Slow price reactions to analysts’ recommendation revisions

This study explores the reasons for the slow price reactions to analysts’ recommendation revisions. We predict that analysts’ recommendation revisions contain earnings-related information that is not incorporated in analysts’ earnings forecasts and that the slow price reaction is attributable to a gradual incorporation of this earnings-related information into stock prices. We find that, consistent with our prediction, stocks with recommendation upgrades subsequently experience more upward earnings forecast revisions than stocks with recommendation downgrades, and that the differences in subsequent stock returns between upgraded and downgraded stocks is attributable to differences between subsequent earnings forecast (especially, FY2 earnings forecast) revisions.     

Underwriting Relationships and Analyst Independence in Europe

This paper examines the accuracy of security analysts’ earnings forecasts and stock recommendations for firms in 13 European countries. We document at least three key findings. First, we find strong evidence that lead and co‐lead underwriter analysts’ earnings estimates and stock recommendations are significantly more optimistic than those provided by unaffiliated analysts. Second, we find that lead and co‐lead underwriter analysts’ earnings forecast and stock recommendations are significantly more optimistic for underwriter stocks than for those they provide for other stocks. Third, we also find evidence that these biases found within earnings forecasts and stock recommendations are not driven by one particular country. In short, these findings suggest that affiliated analysts are more optimistic perhaps to maintain investment banking relations.     

Local institutional investors,information asymmetries,and equity returns

We examine the informational role of geographically proximate institutions in stock markets. We find that both the level of and change in local institutional ownership predict future stock returns, particularly for firms with high information asymmetry; in contrast, such predictive abilities are relatively weak for nonlocal institutional ownership. The local advantage is especially evident for local investment advisors, high local ownership institutions, and high local turnover institutions. We also find that the stocks that local institutional investors hold (trade) earn higher excess returns around future earnings announcements than those that nonlocal institutional investors hold (trade).     

Analysts' Incentives and Street Earnings

We examine whether analysts' incentives are associated with street earnings. Because prior research argues that analysts' incentives to promote stocks increase in the extent to which the stock exhibits glamour characteristics, we predict that analysts are more likely to make income-increasing adjustments in determining street earnings for glamour stocks than for value stocks. We find that analysts are more likely to exclude expense items from street earnings for glamour stocks than for value stocks and that excluded expense items help predict future earnings for glamour stocks but not for value stocks. Overall, our results suggest that analysts' self-interest influences street earnings and this self-interest leads to street earnings that are less useful in predicting future earnings for glamour stocks.     

Stock index adjustments and analysts’ forecast optimism: A quasi-natural experiment on the CSI 300 Index

As stock index adjustments comprise a basic system of capital market, their potential influence on analysts’ earnings forecasts is worthy of research. Based on a research sample of 23 adjustments to the CSI 300 Index from June 2007 to June 2018 and the backup stocks announced during the same period, this study examines the impact of additions to stock index on analysts’ forecast optimism using a staggered difference-in-differences model. The research results show that after stocks are added to the stock index, analysts’ earnings forecast optimism about these stocks increases significantly. Cross-sectional analysis indicates that this increase is more significant when the market is bullish, institutional ownership is low, the ratio of listed brokerage firms is low, star analyst coverage is low, firms show seasoned equity offering activity, the ratio of analysts from the top five brokerage firms ranked by commission income is high, and the analysts’ brokerage firms are shareholders. However, analyst-level tests find that analysts’ ability helps to reduce the impact of additions to stock index on earnings forecast optimism. Furthermore, additions to stock index significantly increase analyst coverage and forecast divergence. Economic consequences tests find additions to stock index significantly increases stock price synchronization, which is partly mediated by analysts’ earnings forecast optimism. This study enriches the literature on the impact of basic capital market systems and analyst behavior. The findings suggest that investors should rationally evaluate analysts’ earnings forecasts for stocks added to the stock index and obtain further information from various channels to improve asset allocation efficiency.     

Do local analysts know more? A cross-country study of the performance of local analysts and foreign analysts

This paper examines whether analysts resident in a country make more precise earnings forecasts for firms in that country than non-resident analysts. Using a sample of 32 countries, we find an economically and statistically significant local analyst advantage even after controlling for firm and analyst characteristics. The local advantage is high in countries where earnings are smoothed more, less information is disclosed by firms, and firm idiosyncratic information explains a smaller fraction of stock returns. It is negatively related to whether a firm has foreign assets and to market participation by foreign investors and by institutions, and positively related to holdings by insiders. The extent to which U.S. investors underweight a country's stocks is positively related to that country's local analyst advantage.     

Do Managers Always Know Better? The Relative Accuracy of Management and Analyst Forecasts

We examine the relative accuracy of management and analyst forecasts of annual EPS. We predict and find that analysts’ information advantage resides at the macroeconomic level. They provide more accurate earnings forecasts than management when a firm's fortunes move in concert with macroeconomic factors such as Gross Domestic Product and energy costs. In contrast, we predict and find that management's information advantage resides at the firm level. Their forecasts are more accurate than analysts’ when management's actions, which affect reported earnings, are difficult to anticipate by outsiders, such as when the firm's inventories are abnormally high or the firm has excess capacity or is experiencing a loss. Although analysts are commonly viewed as industry specialists, we fail to find evidence that analysts have an information advantage over managers at the industry level. The two have comparable abilities to forecast earnings for firms with revenues or earnings that are more synchronous with their industries.     

Evaluating the information content of earnings forecasts

This study develops a framework to compare the ability of alternative earnings forecast approaches to capture the market expectation of future earnings. Given prior evidence of analysts’ systematic optimistic bias, we decompose earnings surprises into analysts’ earnings surprises and adjustments based on alternative forecasting models. An equal market response to these two components indicates that the associated earnings forecast is a sufficient estimate of the market expectation of future earnings. To apply our framework, we examine four recent regression-based earnings forecasting models, alongside a simple earnings-based random walk model and analysts’ forecasts. Using the earnings forecasts of the model that satisfies our sufficiency condition, we identify a set of stocks for which the market is unduly pessimistic about future earnings. The investment strategy of buying and holding these stocks generates statistically signi?cant abnormal returns. We offer an explanation as to why this and similar strategies might be successful.     

Implied cost of capital investment strategies: evidence from international stock markets

Investors can generate excess returns by implementing trading strategies based on publicly available equity analyst forecasts. This paper captures the information provided by analysts by the implied cost of capital (ICC), the internal rate of return that equates a firm’s share price to the present value of analysts’ earnings forecasts. We find that U.S. stocks with a high ICC outperform low ICC stocks on average by 6.0 % per year. This spread is significant when controlling the investment returns for their risk exposure as proxied by standard pricing models. Further analysis across the world’s largest equity markets validates these results.     

Do banks care about analysts' forecasts when designing loan contracts?

We investigate whether banks rely on the information content in equity analysts’ annual earnings forecasts when assessing the risk of potential borrowers. While a long literature finds that analysts provide useful information to market participants, it is not clear that banks, which have access to privileged information, would benefit from publicly available analysts’ forecasts. If, however, banks do rely on this information, then more precise private information in earnings forecasts may inform banks. We focus our analysis on the requirement of collateral because it is a direct measure of default risk, whereas other loan terms such as interest spread and debt covenants can also protect against other risks, such as asset misappropriation. The direct link between collateral and default risk allows us to examine whether information from analysts is relevant to banks when designing loan contracts. Consistent with our predictions, we find that higher precision of the private information in analysts’ earnings forecasts is associated with a lower likelihood of requiring collateral, and this effect is larger when a borrower does not have a prior relationship with the lender or their accounting or credit quality is low. We also find that this association disappears after the implementation of Regulation FD, consistent with this regulation reducing analysts’ access to private information.     

Are analysts’ earnings forecasts more accurate when accompanied by cash flow forecasts?

We examine whether analysts’ earnings forecasts are more accurate when they also issue cash flow forecasts. We find that (i) analysts’ earnings forecasts issued together with cash flow forecasts are more accurate than those not accompanied by cash flow forecasts, and (ii) analysts’ earnings forecasts reflect a better understanding of the implications of current earnings for future earnings when they are accompanied by cash flow forecasts. These results are consistent with analysts adopting a more structured and disciplined approach to forecasting earnings when they also issue cash flow forecasts. Finally, we find that more accurate cash flow forecasts decrease the likelihood of analysts being fired, suggesting that cash flow forecast accuracy is relevant to analysts’ career outcomes.     

The association between quarter length,forecast errors,and firms’ voluntary disclosures

Approximately 60 percent of adjacent fiscal quarters contain a different number of calendar days. In preliminary analyses, we find the change in quarter length is significantly associated with the changes in sales and earnings and that analysts condition on the prior quarter's results when making their forecasts. These results indicate that it is important for analysts to adjust for changes in quarter length when making forecasts. However, we find the quarterly change in days is positively associated with analysts’ sales and earnings forecasts errors, where forecast error equals the actual earnings minus the forecasted earnings. These results indicate that analysts systematically underestimate (overestimate) performance when quarter length increases (decreases). We find evidence indicating investors make similar errors as returns around earnings announcements are positively associated with the change in quarter length, but only when changes in firm performance is more sensitive to changes in quarter length. Corroborating these findings, managers are more (less) likely to discuss quarter length during conference calls when quarter length decreases (increases). These results are consistent with managers’ strategic disclosure incentives. In summary, our evidence suggests analysts and investors fail to fully take account of the quasi-mechanical effect that quarter length has on firm performance and managers strategically alter their voluntary disclosures to take advantage of these failures.     

The quality of street cash flow from operations

We provide empirical evidence on the quality of street cash flow from operations (CFO) as an alternative financial performance summary measure. We focus our investigation on the quality of the items analysts exclude in their determination of street CFO. Based on a sample of 8,518 firm-year observations over the 1993–2008 period, we find that the street CFO number is generally higher than the GAAP CFO number, indicating that analysts typically make CFO-increasing exclusions. Our inspection of hand-collected analyst reports reveals that, while some analysts make sophisticated exclusions of transitory cash items, many others ignore working capital and other accruals when adjusting forecasted earnings to arrive at their street CFO forecasts. We find that street CFO exclusions are negatively associated with future operating earnings, suggesting that these exclusions are not fully transitory or unimportant in forecasting future performance. Our results also indicate that street CFO exclusions are less transitory than the implicit accrual component of analysts’ street earnings exclusions. These results suggest that the average quality of analysts’ street CFO exclusions is quite low and that it is even lower than the quality of their implied accrual exclusions. Moreover, we find that investors perceive analysts’ CFO exclusions to be of such low quality to render street CFO measures less informative than GAAP CFO figures. Finally, we find that analyst conflicts of interest and (to some extent) the greater inherent volatility of firms’ CFO series contribute to the low-quality nature of analysts’ street CFO exclusions.     

The joint information role of analysts’ cash flow and earnings forecasts

We study whether the relative magnitudes of analysts’ cash flow and earnings forecasts convey information about the persistence and value relevance of reported earnings. We find that reported earnings are likely to be more (less) persistent and value relevant when analysts forecast relatively moderate (extreme) levels of operating cash flows, relative to earnings. We also find that the market’s response to a given earnings surprise is the strongest for moderate levels of cash flow forecasts relative to earnings. The joint information role of analysts’ cash flow and earnings forecasts persists even after controlling for the absolute accruals in the model.     

Determinants of analysts’ revenue forecast accuracy

This study investigates financial analysts’ revenue forecasts and identifies determinants of the forecasts’ accuracy. We find that revenue forecast accuracy is determined by forecast and analyst characteristics similar to those of earnings forecast accuracy—namely, forecast horizon, days elapsed since the last forecast, analysts’ forecasting experience, forecast frequency, forecast portfolio, reputation, earnings forecast issuance, forecast boldness, and analysts’ prior performance in forecasting revenues and earnings. We develop a model that predicts the usefulness of revenue forecasts. Thereby, our study helps to ex ante identify more accurate revenue forecasts. Furthermore, we find that analysts concern themselves with their revenue forecasting performance. Analysts with poor revenue forecasting performance are more likely to stop forecasting revenues than analysts with better performance. Their decision is reasonable because revenue forecast accuracy affects analysts’ career prospects in terms of being promoted or terminated. Our study helps investors and academic researchers to understand determinants of revenue forecasts. This understanding is also beneficial for evaluating earnings forecasts because revenue forecasts reveal whether changes in earnings forecasts are due to anticipated changes in revenues or expenses.     

Analyst Forecasts and the Cross Section of European Stock Returns

We examine revisions to earnings forecasts by equity analysts and their role in predicting stock returns. We provide evidence that European stocks with net upward revised forecasts earn higher future returns than otherwise similar stocks. This effect is not concentrated in small stocks, stocks with low analyst coverage, or stocks with low book‐to‐market ratios. We find differences in the return continuation patterns of stocks with upward versus downward revisions, namely, bad news travels quickly, but good news travels slowly. This result is consistent with investors' attaching greater significance to poor earnings forecasts, but adopting a wait‐and‐see approach to good news.     

Does short selling reduce analysts’ optimism bias in earnings forecasts?

We examine the relationship between short selling and analyst optimism bias of earnings forecasts of stocks in China. We propose two possible hypotheses: short selling enhances analysts’ information set to lower optimism bias and analysts drum up optimistic earnings forecasts to counter short selling. Our results suggest that short selling and earnings optimism bias are negatively correlated. The findings are robust to a two-stage least square method, a difference in-differences fixed effect model, an alternative measure of optimism bias, incorporated different time windows to calculate short selling, considered bull and bear market conditions, accounting for media coverage, and using abnormal short selling. By leveraging rich data, we conduct additional analyses using stocks with different forecasting horizons and earnings forecasts that were made after the accounting year but prior to the earnings announcement to further support expanding the information set argument. Lastly, we document that short selling information improves the accuracy of earnings forecasts.     

THE ASSOCIATION BETWEEN ANALYSTS’ FORECAST REVISIONS AND EARNINGS COMPONENTS: THE EVIDENCE OF FRS 3

This study examines whether the earnings components as required by FRS 3 help UK analysts to predict firms’ earnings changes by investigating the statistical association between analysts’ forecast revisions and firms’ unexpected earnings components. I find that analysts’ forecast revisions made in different time horizons are consistently associated with unexpected earnings components as required by FRS 3. UK analysts are able to incorporate current-year unexpected earnings components into their current and future earnings forecasts even before firms officially release this information. However, empirical results also show that current-year unexpected earnings components are not fully incorporated into analysts’ forecasts of future earnings. Analysts appear to wait for more information releases regarding firms’ future earnings and delay their revisions of future earnings forecasts. This is consistent with the evidence that the cumulative revisions of current earnings forecasts are generally associated with prior-year unexpected earnings components, and the association appears to be stronger as time progresses. Overall, this study provides evidence suggesting that the earnings components as required by FRS 3 help UK analysts to identify firms’ permanent and transitory earnings changes over different forecast horizons. This study also provides strong evidence supporting the informativeness of earnings components for analysts’ forecasts and the information set perspective of FRS 3 that highlights the importance of earnings components in predicting a reporting entity’s future performance.     

Informed local trading prior to earnings announcements

Do individual investors have better information about local stocks? Our results demonstrate that they do. Large trading imbalances by investors living close to a firm's headquarters predict the stock's earnings announcement return. Stocks with the most net buying by local investors average significantly higher market-adjusted announcement returns than stocks with the most net selling by local investors. This return difference is pronounced for small and medium-sized firms, but absent among large firms, which have significant analyst coverage. Local investors' information advantage comes at the expense of nonlocal traders.     

Fair Value‐related Information in Analysts’ Decision Processes: Evidence from the Financial Crisis

We use a sample of conference calls and analyst research reports from international banks to examine how financial analysts request and communicate fair value‐related information in their valuation process. We find that analysts devote considerable attention to fair value‐related topics. Most of the conference call questions and references in research reports pertain to fair value reclassifications and fair value changes of liabilities resulting from banks’ own credit risk. The accounting impact of these one‐time effects during the financial crisis and a lack of corresponding firm disclosures help to explain the prevalence of these two topics. The content of the questions and references suggests that analysts have different motives for their interest in fair value‐related information. While some analysts adjust reported earnings for unrecognised fair value changes of reclassified assets, most of the observed analysts exclude banks’ own credit risk effects from reported earnings. Thus, the use of fair value‐related information varies substantially across analysts and across instruments.