ABNORMAL RETURNS AND ANALYSTS' EARNINGS FORECAST REVISIONS ASSOCIATED WITH THE PUBLICATION OF “STOCK HIGHLIGHTS” BY VALUE LINE INVESTMENT SURVEY

We examine the reaction of stocks and the response of financial analysts' earnings forecasts to securities recommended as “Stock Highlights” by Value Line Investment Survey. Significant abnormal returns appear around the publication of stock highlights. Stock price responses are relatively efficient and permanent. Using earnings expectation data provided by the Institutional Brokers Estimate System, we find analysts raise their forecasts significantly following Value Line recommendations. Near-term forecast revisions are significantly related to stock returns at the time of the recommendations. Thus, an explanation for Value Line's security recommendation success is its ability to generate firm-specific earnings information.     

Testing and Aggressive Investment Strategy Using Value Line Ranks: A Reply

This paper answers the comments of readers of our earlier paper. Additional insight is gained by adding recent data to show the effect of following Value Line Investment Service recommendations in active stock market trading over the years 1974–81. We show that Value Line makes a statistically significant contribution, which cannot be explained by the Beta risk factor. We offer our results as an unexplained divergence from the Efficient Market Hypothesis, but with the tentative hypothesis that investment timing (i.e., the fact that the Efficient Market Hypothesis does not operate instantaneously) may explain much of the abnormality.     

THE VALUE LINE STOCK RANKINGS AND THE OPTION MODEL IMPLIED STANDARD DEVIATIONS

Here, the relationship between Value Line rankings and option implied standard deviations is investigated. Each Value Line ranking (safety, price stability, timeliness, and earnings predictability) is significantly related to option implied standard deviations for a sample of 62 companies with Value Line timeliness rankings of 1, 2, 4, and 5 and with a total of 1,217 call options traded over a 3-day period. The index for price stability would be most valuable to investors for assessing future risk since only this index has a significant association with residual implied volatility, i.e., those unexplained by historical volatility.     

A NOTE ON THE VALUE LINE STOCK HIGHLIGHT EFFECT

Each week Value Line highlights one or two timeliness rank 1 stocks. We find a significant 2.65 percent three-day return around this event. However, this effect is temporary and largely reverses over the next several weeks. We also find that the market response to a highlighted stock is stronger when the stock has a lower price/earnings ratio, is smaller, and has fewer institutional owners. We cannot find evidence against the semistrong form of the efficient market hypothesis. Finally, we present a hypothesis examining whether a favorable Value Line report permanently or temporarily affects stock price.     

Unraveling a puzzle: the case of value line timeliness rank upgrades

We examine a sample of Value Line’s timeliness rank upgrades that occur immediately following earnings announcements and find that pre-event price momentum has significant incremental explanatory power for post-event drift, after controlling for the level of earnings surprise. Therefore, the stock price drift following Value Line’s timeliness upgrades cannot be viewed as driven only by the post-earnings announcement drift phenomenon. Instead, these findings indicate that, among other factors, Value Line has been exploiting the price momentum effect for decades. Black (Financ. Anal. J. 29:10–14, 1973) clearly stated that it does indeed do this, but his assertion has not yet been verified as an explanation of the puzzling drift that follows Value Line rank upgrades.     

Investor response to online value line rank changes: Foreign versus local stocks

We find that the Value Line effect is confined to U.S. stocks. U.S. listed stocks significantly outperform their benchmarks long after Value Line Timeliness rank change announcements. In contrast, we find no evidence of a Value Line effect for recommendations made for foreign stocks that list on U.S. exchanges, nor for those that list outside the U.S. For days surrounding rank change announcements, trading volume is abnormally high for U.S. listed stocks, but remains unchanged for the foreign stock sample. Our findings are unchanged after controlling for unique valuation challenges, varying market conditions, beta, firm size, book-to-market, momentum, and post earnings announcement effects.     

THE VALUATION EFFECTS OF OUT-OF-THE-MONEY CALLS OF CONVERTIBLE SECURITIES

We examine the valuation effects of out-of-the-money calls of convertible securities. In general, out-of-the-money calls generate positive abnormal stock returns. These returns are higher when the call price exceeds the market value of the called securities (positive premium calls), compared with when the market value exceeds the call price (negative premium calls). Furthermore, Value Line Investment Survey net operating income forecasts are significantly higher after call announcements for positive premium calls, while the revision is insignificant for negative premium calls. The results are consistent with the hypothesis that positive premium calls signal positive information.     

The Pricing of Futures and Options Contracts on the Value Line Index

This paper considers the problems peculiar to the Value Line Index, because of its use of geometric averaging, as regards the pricing of options and futures on that index. The Value Line Composite Index (VLCI) is an equally weighted geometric average index of nearly 1700 stocks. The VLCI futures market has existed since 1982 while the VLCI options market was established in 1985. This paper provides valuation formulas and analyzes the economic properties of these contracts. Because of the geometric averaging in the VLCI, its contingent claims have special properties. For example, the futures price may fall short of the spot price and the value of a VLCI call option may decline when the volatility of the index is increased. VLCI futures are shown to provide a direct means for duplicating an equally weighted portfolio of the underlying stocks.     

The value line enigma (1965–1978): A case study of performance evaluation issues

The performance of Value Line Investment Survey recommendations made between 1965 and 1978 is evaluated by applying a future benchmark technique. The future benchmark technique avoids selection bias problems associated with using historic benchmarks as well as known difficulties of using Capital Asset Pricing Model benchmarks. Potential problems (implicit in the technique) are discussed and resolved within the conduct of the experiment. Results indicate statistically significant abnormal performance when future benchmarks are computed using a market model.     

Rare disaster risk and the expected equity risk premium

Consistent with the predictions of rare disaster models, we find that a proxy for the time‐varying probability of rare disasters helps to explain fluctuations in expectations of the equity risk premium. Our proxy for disaster risk is a recently developed measure of global political instability, and the expected market risk premium is from Value Line analysts' expected stock returns. Consistent with long‐run risk models, uncertainty about expected GDP growth and expected consumption growth is also significantly positively related to the expected market risk premium. We obtain similar results when we use the earnings–price ratio and the dividend–price ratio as proxies for the expected market risk premium.     

Yes,The Value Line Enigma Is Still Alive: Evidence from Online Timeliness Rank Changes

Beginning June 9, 2005, Value Line started announcing its Timeliness changes online at 10:00 a.m. on Thursday, one day earlier than Friday noon's post‐delivery. We confirm that the Value Line effect still exists but shifts to Thursday in the Internet era. Unlike previous findings, the next‐day abnormal return after the announcement has disappeared, suggesting that the market efficiently priced the change. We find that a portfolio upgraded from rank 5 to 4 gains the highest cumulative abnormal return of 9.07% over a 50‐day window. Finally, we find that the post‐earnings announcement drift does not explain the Value Line enigma.     

AN EVALUATION OF THE PERFORMANCE OF PORTFOLIOS SELECTED FROM VALUE LINE RANK ONE STOCKS: 1976–1982

In this study, the performance of portfolios selected from among Value Line rank one stocks is compared with portfolios consisting of randomly selected New York Stock Exchange and American Stock Exchange stocks. Results indicate that before considering transactions costs, active traders who invest in Value Line rank one stocks can earn positive excess returns. However, after considering transaction costs, neither active traders nor passive investors in rank one stocks can earn returns that are statistically greater than returns achieved by portfolios of randomly selected stocks. These results are not sensitive to variations in portfolio size.     

The effect of value line investment survey rank changes on common stock prices

The information content of Value Line Investment Survey rank changes is investigated. The results suggest rank changes affect common stock prices, but the effect varies by the type of rank change. Changes from rank 2 to rank 1 have the most dramatic impact on prices. A cross-sectional analysis finds small firms have a greater reaction to a rank change than larger firms, which supports theories on the frequency of report arrival and precision of information. A speed of adjustment test concludes the prices of individual securities adjust to the information in a rank change over a multiple-day period.     

Bucking the Trend: The Informativeness of Analyst Contrarian Recommendations

This paper examines price reactions to analysts’ recommendations issued in the opposite direction of recent stock price movements. We find that upgrade and downgrade contrarian recommendations induce larger market reactions than noncontrarian recommendations, consistent with the view that they are more informative. These results are strongest in the period before Regulation Fair Disclosure, consistent with the view that private information was likely curbed after its implementation. Contrarian downgrades are more likely to be issued by all‐star analysts, but less likely by experienced and busy analysts suggesting that contrarian recommendations are subject to career concerns.     

Relative accuracy and predictive ability of direct valuation methods, price to aggregate earnings method and a hybrid approach

In this paper, we assess the relative performance of the direct valuation method and industry multiplier models using 41 435 firm‐quarter Value Line observations over an 11 year (1990–2000) period. Results from both pricing‐error and return‐prediction analyses indicate that direct valuation yields lower percentage pricing errors and greater return prediction ability than the forward price to aggregated forecasted earnings multiplier model. However, a simple hybrid combination of these two methods leads to more accurate intrinsic value estimates, compared to either method used in isolation. It would appear that fundamental analysis could benefit from using one approach as a check on the other.     

The First‐ and Second‐Hand Effect of Analysts' Stock Recommendations: Evidence from the Swiss Stock Market

This paper empirically investigates the impact of both the first release of analysts' stock recommendations to a limited clientele and the subsequent dissemination of the same information in a major newspaper to a broader audience. For a sample of 1460 stock recommendations published in FuW, Switzerland's major financial newspaper, significant positive abnormal returns on the day of the original release of buy recommendations and on the day of publication in FuW are documented. Tests of the price pressure and information hypotheses reveal that analysts' recommendations contain new information, which is quickly incorporated in the stock prices on the first release of this information. In contrast, the statistically significant announcement effects associated with the subsequent publication can be primarily ascribed to price pressure in the underlying securities.     

Regulation fair disclosure and the market’s reaction to analyst investment recommendation changes

Previous research has shown that affiliated analysts (those who are working for investment banks that underwrite securities for companies) have an incentive to provide optimistically biased recommendations from selective information they are given by the firm. In an effort to halt such activities, as of October 2000, Regulation Fair Disclosure (RegFD) prohibits selective disclosure of material non-public information by public companies to privileged individuals (such as favored research analysts) and requires broad, non-exclusionary disclosure of such information. We examine firms’ stock price reactions to investment recommendation changes from affiliated analysts versus unaffiliated analysts from October 1998 to November 2002, around the passage of RegFD. Similar to previous research, we find that investors reacted more significantly to recommendation downgrades by affiliated analysts than to those by unaffiliated analysts prior to the passage of RegFD. However, we find that the difference in the reactions to recommendation changes is not present after the passage of RegFD. We also find that stock price reactions to analysts’ (both affiliated and unaffiliated) recommendation changes decreased significantly after the passage of RegFD. Thus, RegFD appears to have curbed the selective disclosure of information (particularly negative information) by firms to affiliated analysts. Further, the smaller reactions to recommendation changes by all analysts after RegFD may reflect a change in analysts’ behavior (irrespective of information that is available) or a response by corporate managers to withhold information rather than risking a violation of fair disclosure rules.     

Analysts and anomalies

Analysts' price targets and recommendations contradict stock return anomaly variables. Using an index based on 125 anomalies, we find that analysts' annual stock return forecasts are 11% higher for anomaly-shorts than for anomaly-longs. Anomaly-shorts’ return forecasts are excessively optimistic, exceeding realized returns by 34%. Recommendations also tend to be more favorable for anomaly-shorts, although this result varies across anomaly types. Consistent with analysts' slowly incorporating anomaly information, anomalies forecast revisions in both price targets and recommendations. Our findings imply that investors who follow analysts' actionable information contribute to mispricing.     

Are Economically Significant Stock Returns and Trading Volumes Driven by Firm‐specific News Releases?

This paper explores whether firm‐specific information events drive economically relevant positive and negative stock price changes and trading volume and, if so, the nature of such information. We find that no less than 65% of significant price changes and trading volume movements in our sample of FTSE 350 companies can be readily explained by public domain information contradicting the thesis that corporate news is not a primary driver, and that share price changes and trading volume activity are driven by factors unrelated to information flows per se. In addition, we find that a parsimonious set of news categories represent the key drivers. Sell‐side analyst stock recommendations and earnings forecast revisions as a class, unaccompanied by other news releases, dominate all other news categories in terms of significant market reaction. However, taking into account the relative magnitude of market response to different news releases, firms' formal accounting disclosures dominate within this domain. As such, we conclude these are not fully anticipated by apparently more timely market disclosures, and that the existence of news services and the activities of the sell‐side analyst are not substitutes for a firm's interim and preliminary results.