Finding Diamonds in the Rough: Analysts’ Selective Following of Loss‐Reporting Firms

26 Pages Posted: 8 Feb 2018

See all articles by Donal Byard

Donal Byard

City University of New York - Stan Ross Department of Accountancy

Masako N. Darrough

Baruch College - CUNY

Jangwon Suh

New York Institute of Technology

Yao Tian

San Jose State University

Date Written: January/February 2018

Abstract

Investors face greater difficulty valuing loss‐reporting than profit‐reporting firms: losses may be due to very different reasons (e.g., poor operating performance or investments in intangibles, and financial accounting information is of more limited use for valuing loss‐making firms than profit‐making firms. Because of increased uncertainty about loss firms’ future financial and business viability, we hypothesize that financial analysts will be more selective when choosing to follow loss firms than profit firms, with the result that “abnormal” analyst following will be more informative to investors regarding the future performance of loss firms than profit firms. Consistent with this prediction, we find that abnormal analyst coverage is useful for predicting firms’ future prospects, and is more strongly associated with future performance (stock returns and ROA) for loss firms than for profit firms. The market, however, does not seem to use this useful information when pricing loss firms: for loss firms a portfolio investment strategy based upon abnormal analyst following can generate positive excess returns over 1‐ to 3‐year holding periods. These results are stronger for persistent‐loss firms than for occasional‐loss firms. We conclude that abnormal analyst following contains useful information about firms’ future prospects, and even more so for loss firms than for profit firms.

Keywords: analyst following, future performance, loss firms, self‐selection

Suggested Citation

Byard, Donal and Darrough, Masako N. and Suh, Jangwon and Tian, Yao, Finding Diamonds in the Rough: Analysts’ Selective Following of Loss‐Reporting Firms (January/February 2018). Journal of Business Finance & Accounting, Vol. 45, Issue 1-2, pp. 140-165, 2018, Available at SSRN: https://ssrn.com/abstract=3120057 or http://dx.doi.org/10.1111/jbfa.12269

Donal Byard (Contact Author)

City University of New York - Stan Ross Department of Accountancy ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States
646-312-3187 (Phone)
646-312-3161 (Fax)

Masako N. Darrough

Baruch College - CUNY ( email )

One Bernard Baruch Way
New York, NY 10010
United States
646 312 3183 (Phone)
646 312 3161 (Fax)

Jangwon Suh

New York Institute of Technology ( email )

1855 Broadway
New York, NY 10023
United States

Yao Tian

San Jose State University ( email )

San Jose, CA 95192-0066
United States
6505268206 (Phone)

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