The Geography of Equity Analysis

I provide evidence that geographically proximate analysts are more accurate than other analysts. Stock returns immediately surrounding forecast revisions suggest that local analysts impact prices more than other analysts. These effects are strongest for firms located in small cities and remote areas. Collectively these results suggest that geographically proximate analysts possess an information advantage over other analysts, and that this advantage translates into better performance. The well‐documented underwriter affiliation bias in stock recommendations is concentrated among distant affiliated analysts; recommendations by local affiliated analysts are unbiased. This finding reveals a geographic component to the agency problems in the industry.     

The influence of buy-side analysts on mutual fund trading

We present evidence on the trading and performance impact of buy-side analysts. Using data provided by a large global asset manager, we relate buy-side analysts’ recommendations to fund transactions on a daily basis. We show that buy-side analysts significantly influence trading decisions: Fund managers strongly follow recent recommendation revisions, even after controlling for other trading determinants. Positive abnormal returns to buy-side analysts’ revisions are also reflected in the performance of mutual fund trades: Trades triggered by buy-side recommendations have higher returns than other trades. Overall, the impact of buy-side analysts is more pronounced than that of sell-side analysts.     

Analysts’ Momentum Recommendations

We document that the likelihood of analyst recommendations following past stock returns decreased abruptly in 2003, coinciding with the Global Settlement and other regulatory changes designed to restrain analysts’ conflicts of interest. We also document that the likelihood of recommendations following past stock returns is abnormally high for recommendations issued after negative stock returns (but not for those issued after positive stock returns), among inexperienced and inaccurate analysts, among large brokerage houses, and for companies with high share turnover. Moreover, the recommendations that are more likely to follow past stock returns are accompanied by earnings forecast revisions that are larger in magnitude and less accurate ex post. Overall, our findings suggest that analysts with conflicts of interest and limited ability are more likely to base their recommendations on past stock returns. Finally, we document that the recommendations that are more likely to follow past stock returns (especially those that were issued before 2003 and those that are issued after negative stock returns) contribute to existing price momentum by generating incrementally stronger short‐term and long‐term stock returns.     

The superiority and disciplining role of independent analysts

We show that although forecasts of independent analysts are less accurate ex post, they yield forecast errors that are more strongly associated with abnormal stock returns. This suggests that forecasts of independent analysts are superior to those of nonindependent analysts in representing ex ante market expectations. We also show that forecasts of nonindependent analysts become more accurate and less biased, and produce forecast errors more strongly associated with abnormal stock returns when independent analysts are following the same firms than when they are not. This suggests that the presence of independent analysts disciplines the behavior of nonindependent analysts.     

Earnings Forecasts and the Information Contained in Spinoff Announcements

This study examines spinoff announcements in conjunction with financial analysts’ forecasts of earnings. The analysis shows that spinoff announcement abnormal returns are significantly related to the firm's information environment as proxieci by financial analysts’ earnings prediction errors. The findings also indicate that analysts significantly increase their short-term earnings forecasts in response to spinoffs, but do not significantly revise their long-term earnings forecasts. However, the earnings revisions are not significantly different across prediction error groups, which confirms that spinoff-related abnormal returns cannot be attributed solely to expected performance gains.     

THE EFFECT OF SELF-TENDER OFFERS ON EARNINGS EXPECTATIONS

We examine financial analysts' earnings revisions after self-tender offers. Consistent with the assertions of earlier studies that self-tender offers signal future performance, financial analysts significantly increase their forecasts of earnings for firms that announce self-tender offers. However, the revisions differ based on the method chosen to repurchase shares. For Dutch auction offers, analysts significantly revise their estimates of short-term earnings only. For fixed-price tender offers, analysts increase both short-term and long-term earnings estimates. Also, long-term earnings revisions are significantly related to announcement-period abnormal returns for fixed-price tender offers, which suggests that fixed-price self-tender offers convey more positive information about future earnings than do Dutch auction offers.     

Understanding analysts' use of stock returns and other analysts' revisions when forecasting earnings

We investigate analysts' use of stock returns and other analysts' forecast revisions in revising their own forecasts after an earnings announcement. We find that analysts respond more strongly to these signals when the signals are more informative about future earnings changes. Although analysts underreact to these signals on average, we find that analysts who are most sensitive to signal informativeness achieve superior forecast accuracy relative to their peers and have a greater influence on the market. The results suggest that the ability to extract information from the actions of others serves as one source of analyst expertise.     

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.     

Underwriting relationships,analysts' earnings forecasts and investment recommendations

We examine the effect of underwriting relationships on analysts' earnings forecasts and recommendations. Lead and co-underwriter analysts' growth forecasts and recommendations are significantly more favorable than those made by unaffiliated analysts, although their earnings forecasts are not generally greater. Investors respond similarly to lead underwriter and unaffiliated `Strong buy' and `Buy' recommendations, but three-day returns to lead underwriter `Hold' recommendations are significantly more negative than those to unaffiliated `Hold' recommendations. The findings suggest investors expect lead analysts are more likely to recommend `Hold' when `Sell' is warranted. The post-announcement returns following affiliated and unaffiliated analysts' recommendations are not significantly different.     

Reg-FD and the competitiveness of all-star analysts

We examine the impact of Regulation Fair Disclosure on the competitive advantage of All-Star analysts as measured by turnover in the rankings. Institutional Investor All-Americans, chosen by votes of institutional investors based on overall helpfulness, experienced a significant increase in turnover as Reg-FD was implemented. Non-US analysts and US analysts ranked solely on the basis of public stock recommendations did not. Within a few years, however, All-American turnover returned to pre-Reg-FD levels, suggesting that the new All-Americans built a competitive advantage stressing aspects of performance less dependent on privileged communication.     

Analyst reputation and management earnings forecasts

Prior studies show that analysts with high reputation are influential in the market. This paper examines whether managers consider analyst reputation in shaping their voluntary disclosure strategy. Using Institutional Investor magazine’s All-American (AA) rankings as a proxy for analyst reputation, we find that the coverage of AA analysts is positively associated with the likelihood of quarterly management earnings forecasts (MEFs). We also find that AA analysts’ forecast optimism is more positively associated with the likelihood of MEFs than non-AA analysts’ forecast optimism when the firm is covered by AA analysts. Analyses based on AA analyst coverage changes and AA status changes confirm the relation between analyst reputation and MEFs. We further find that analyst reputation influences other MEF properties, such as forecast news, bias, and revisions, and that our results are robust to alternative measures of analyst reputation. Further analyses show that market reactions at quarterly earnings announcements are more positive (negative) when firms meet/beat (miss) AA analysts’ forecasts than when firms meet/beat (miss) non-AA analysts’ forecasts. Collectively, our findings suggest that managers strategically provide voluntary forecasts by taking into account the reputation of individual analysts following their firms.     

Do sell-side analysts exhibit differential target price forecasting ability?

We examine the overall and individual analyst performance of 12-month-ahead target price forecasts over the 10 years from 2000 through 2009. Implied target price-based returns exceed actual returns by an average of 15 %, and absolute target price forecast errors average 45 %. At the end of the 12-month forecast horizon, only 38 % of target prices are met, but 64 % are met at some time during the forecast horizon. We find statistically significant but economically weak evidence of persistent differential abilities by sell-side analysts to forecast target prices. Target price announcement period return analyses indicate no differential market reactions to analysts’ target price revisions conditional on their recent target price forecast performance. This finding is consistent with the market understanding that analysts have, at best, limited abilities to persistently provide accurate target price forecasts.     

Analyst characteristics, timing of forecast revisions, and analyst forecasting ability

We first examine whether analysts with certain characteristics that prior research has identified are related to superior forecasting ability systematically time their forecast revisions later in the fiscal quarter. We then examine whether this superior ability persists after controlling for the timing advantage by using relative forecast error, a measure that largely eliminates the timing advantage of recent forecasts. Using a sample of quarterly earnings forecast revisions over the 20-year period from 1990 to 2009, we find that analysts with more firm-specific and general experience and more accurate prior-period forecasts, analysts employed by larger brokerage firms, and analysts who follow fewer industries and companies tend to revise forecasts later in the quarter. We also find that analyst characteristics that are positively correlated with revision timing are negatively related to relative forecast errors. These results are consistent with analyst characteristics being useful proxies for analyst forecasting ability and analysts with greater ability revising forecasts later in the quarter.     

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.     

The Performance of Equity Analysts During the Global Financial Crisis

This paper investigates the response of equity analysts following Australian and US listed stocks to the onset of the 2007 Global Financial Crisis. Both groups of analysts reacted quickly by adjusting their forecasts downwards, and initially tending towards being overly pessimistic. Relative to pre‐crisis data, the authors identify sharp declines in earnings forecasts, an increase (decrease) in downward (upward) revisions, and a downward (upward) trend in sell (buy) recommendations. Forecast errors are larger, and dispersion of earnings forecasts is higher. Finally, the most accurate analysts in the pre‐crisis period continue to be significantly more accurate during the crisis period than their peers.     

What Drives Target Price Forecasts and Their Investment Value?

This paper examines the informativeness of analysts’ target price forecasts by relating the investment value of target prices to their primary drivers. Decomposing target price forecasts into near‐term earnings forecasts and price‐to‐earnings ratio forecasts, we show that target price revisions reflect information from both components. In addition, we also find that the relative importance of each component in target price revisions is related to firm characteristics. A portfolio based on target price implied expected returns delivers significant abnormal returns. More importantly, we find that the abnormal returns are associated with both earnings and price‐to‐earnings forecasts, which suggests that the informativeness of target price forecasts comes not only from analysts’ ability to forecast short‐term earnings but also from their ability to assess risk and long‐term growth prospect implied in price‐to‐earnings forecasts.     

What do analysts do? Discussion of “Information interpretation or information discovery: which role of analysts do investors value more?”

Three decades of accounting and finance research has extensively studied the outputs from financial analysts. However, there is sparse systematic evidence on what analysts do to generate their outputs in the form of forecasts, recommendations, and research reports. Livnat and Zhang (Rev Account Stud, 2012) provide interesting new evidence regarding the relative amount of value added that analysts produce by examining investors?? reaction to analysts?? forecast revisions issued promptly after firms?? public disclosures compared with those issued at other times. Their analysis shows that prompt revisions are associated with larger returns, which the authors interpret as evidence that analysts?? ability to interpret public disclosures is more valuable to investors. Three issues bear consideration in the interpretation of these findings.     

Consistency in meeting or beating earnings expectations and management earnings forecasts

This paper provides evidence that firms that have consistently met or beaten analysts’ earnings expectations (MBE) provide more frequent “bad news” management forecasts than firms with no established string of MBE, particularly when existing analyst forecasts are optimistic. This suggests that firms with a consistent MBE record are more likely to guide analysts’ expectations downward to avoid breaking the consistency. Subsequent analyst forecast revisions following bad news management forecasts issued by these firms are dampened, implying that analysts suspect that these forecasts may be opportunistic. The relation between management forecasts and MBE consistency is stronger after Regulation FD.     

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.     

Investor and (Value Line) Analyst Underreaction to Information about Future Earnings: The Corrective Role of Non-Earnings-Surprise Information

Prior research suggests that financial analysts' earnings forecasts and stock prices underreact to earnings news. This paper provides evidence that analysts and investors correct this underreaction in response to the next earnings announcement and to other (non-earnings-surprise) information available between earnings announcements. Our evidence also suggests that analysts and investors underreact to information reflected in analysts' earnings forecast revisions and that non-earnings-surprise information helps correct this underreaction as well. Controlling for corrective non-earnings-surprise information significantly increases estimates of the degree to which analysts' forecasting behavior can explain drifts in returns following both earnings announcements and analysts' earnings forecast revisions.