information trading: following the analystspeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27%...
TRANSCRIPT
![Page 1: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/1.jpg)
INFORMATIONTRADING:FOLLOWINGTHEANALYSTS
AswathDamodaran
![Page 2: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/2.jpg)
2
Analysts:Thecaseforinformationadvantages
¨ Analystshaveaccesstopublicinformationandtothemanagersofthefirm(andthusperhapstoprivateinformation).
¨ Analystsare“sector”specialistswhocanusetheirknowledgetobetterassessvalueforindividualcompanies.
¨ Analystsmakeearningsforecastsforfirms(andrevisethem)andrecommendationsonbuyandsell.
![Page 3: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/3.jpg)
3
Whodoanalystsfollow?
!
![Page 4: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/4.jpg)
4
Determinantsofanalystfollowing…
1. MarketCapitalization:Thelargerthemarketcapitalizationofafirm,themorelikelyitistobefollowedbyanalysts.
2. InstitutionalHolding:Thegreaterthepercentofafirm’sstockthatisheldbyinstitutions,themorelikelyitistobefollowedbyanalysts.Theopenquestion,though,iswhetheranalystsfollowinstitutionsorwhetherinstitutionsfollowanalysts.Giventhatinstitutionalinvestorsarethebiggestclientsofequityresearchanalysts,thecausalityprobablyrunsbothways.
3. TradingVolume:Analystsaremorelikelytofollowliquidstocks.Hereagain,though,itisworthnotingthatthepresenceofanalystsandbuy(orsell)recommendationsonastockmayplayaroleinincreasingtradingvolume.
![Page 5: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/5.jpg)
5
I.EarningsForecasts
• Analystsspendaconsiderableamountoftimeestimatingtheearningspersharethatcompanieswillreportinthenextquarter.Theyalsoprovideforecastsofearningsfurtherout- upto5years.
• Analystsalsoconstantlyupdatetheseforecastsasnewinformationcomesout.Totheextentthatthereisinformationintheserevisions,stockpricesshouldreact.
![Page 6: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/6.jpg)
6
InformationinEarningsForecasts
• Firm-specificinformationthathasbeenmadepublicsincethelastearningsreport:Analystscanuseinformationthathascomeoutaboutthefirmsincethelastearningsreport,tomakepredictionsaboutfuturegrowth.
• Macro-economicinformationthatmayimpactfuturegrowth:Analystscanupdatetheirprojectionsoffuturegrowthasnewinformationcomesoutabouttheoveralleconomyandaboutchangesinfiscalandmonetarypolicy.
• Informationrevealedbycompetitorsonfutureprospects:Analystscanalsoconditiontheirgrowthestimatesforafirmoninformationrevealedbycompetitorsonpricingpolicyandfuturegrowth.
• Privateinformationaboutthefirm:Analystssometimeshaveaccesstoprivateinformationaboutthefirmstheyfollowwhichmayberelevantinforecastingfuturegrowth.
• Publicinformationotherthanearnings:Ithasbeenshown,forinstance,thatotherfinancialvariablessuchasearningsretention,profitmarginsandassetturnoverareusefulinpredictingfuturegrowth.Analystscanincorporateinformationfromthesevariablesintotheirforecasts.
![Page 7: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/7.jpg)
7
TheQualityofEarningsForecasts
¨ Betterthanusinghistoricalearnings:Thegeneralconsensusfromstudiesthathavelookedatshort-termforecasts(onequarteraheadtofourquartersahead)ofearningsisthatanalystsprovidebetterforecastsofearningsthanmodelsthatdependpurelyuponhistoricaldata.Themeanrelativeabsoluteerror,whichmeasurestheabsolutedifferencebetweentheactualearningsandtheforecastforthenextquarter,inpercentageterms,issmallerforanalystforecaststhanitisforforecastsbaseduponhistoricaldata.
¨ Butnotbymuchandonlyselectively:Astudyin1978measuredthesquaredforecasterrorsbymonthoftheyearandcomputedtheratioofanalystforecasterrortotheforecasterrorfromtime-seriesmodelsofearnings.ItfoundthatthetimeseriesmodelsactuallyoutperformanalystforecastsfromApriluntilAugust,butunderperformthemfromSeptemberthroughJanuary.
¨ Andforthenearterm:TheotherstudybyO'Brien(1988)foundthatanalystforecastsoutperformthetimeseriesmodelforone-quarteraheadandtwo-quarteraheadforecasts,doaswellasthetimeseriesmodelforthree-quarteraheadforecastsanddoworsethanthetimeseriesmodelforfour-quarteraheadforecasts.
![Page 8: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/8.jpg)
8
AnalystErrorsseemtoberelatedtomacroeconomicconditions…
![Page 9: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/9.jpg)
9
Howaboutlongtermforecasts?
¨ Thereislittleevidencetosuggestthatanalystsprovidesuperiorforecastsofearningswhentheforecastsareoverthreeorfiveyears.¤ AnearlystudybyCraggandMalkiel comparedlong-termforecastsbyfiveinvestmentmanagementfirmsin1962and1963withactualgrowthoverthefollowingthreeyearstoconcludethatanalystswerepoorlongtermforecasters.
¨ Thisviewwascontestedin1988byVanderWeide andCarletonwhofoundthattheconsensuspredictionoffive-yeargrowthintheI/B/E/Swassuperiortohistoricallyorientedgrowthmeasuresinpredictingfuturegrowth.
![Page 10: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/10.jpg)
10
MarketReactiontoEarningsRevisions…
¨ Earningsrevisionsandstockreturns:Inoneoftheearlieststudiesofthisphenomenon,GivolyandLakonishokcreatedportfoliosof49stocksinthreesectors,baseduponearningsrevisions,andreportedearninganexcessreturnon4.7%overthefollowingfourmonthsonthestockswiththemostpositiverevisions.
¨ Extremerevisions:Hawkins,in1983,reportedthataportfolioofstockswiththe20largestupwardrevisionsinearningsontheI/B/E/Sdatabasewouldhaveearnedanannualizedreturnof14%asopposedtotheindexreturnofonly7%.
¨ NeartermvsLongterm:Inanotherstudy,Cooper,DayandLewisreportthatmuchoftheexcessreturnsisconcentratedintheweeksaroundtherevision–1.27%intheweekbeforetheforecastrevision,and1.12%intheweekafter,andthatanalyststhattheycategorizeasleaders(basedupontimeliness,impactandaccuracy) haveamuchgreaterimpactonbothtradingvolumeandprices.
¨ Inothercountries:In2001,Capstaff,PaudyalandReesexpandedtheresearchtolookatearningsforecastsinothercountriesandconcludedthatyoucouldhaveearnedexcessreturnsof4.7%intheU.K,2%inFranceand3.3%inGermanyfrombuyingstockswiththemostpositiverevisions.
![Page 11: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/11.jpg)
11
PotentialPitfallsandpossibleuse…
¨ Weakestlinks:Thelimitationofanearningsmomentumstrategyisitsdependenceontwooftheweakestlinksinfinancialmarkets –earningsreportsthatcomefromfirms(whereaccountinggamesskewearnings)andanalystforecastsoftheseearnings(whichareoftenbiased).
¨ Clienttrading:Totheextentthatanalystsinfluencetradesmadebytheirclients,theyarelikelytoaffectpriceswhentheyreviseearnings.Themoreinfluentialtheyare,thegreatertheeffecttheywillhaveonprices,butthequestioniswhethertheeffectislasting.
¨ Shortterm:Itisashort-termstrategythatyieldsfairlysmallexcessreturnsoverinvestmenthorizonsrangingfromafewweekstoafewmonths.
¨ Keyanalysts:Onewayyoumaybeabletoearnhigherreturnsfromthisstrategyistoidentifykeyanalystsandbuildaninvestmentstrategyaroundforecastrevisionsmadebythem,ratherthanlookingatconsensusestimatesmadebyallanalysts.Whileforecastrevisionsandearningssurprisesbythemselvesareunlikelytogeneratelucrativeportfolios,theycanaugmentothermorelong-termscreeningstrategies.
![Page 12: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/12.jpg)
12
II.Recommendations:Somebackground
!
![Page 13: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/13.jpg)
13
MarketReaction…
![Page 14: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/14.jpg)
14
Temperedbyfearsofbias…
![Page 15: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/15.jpg)
15
UsingAnalystRecommendations…
• Canyoumakemoneyoffanalystrecommendations?– Stockpricesshouldgouponrecommendations,evenifthereisnonew
informationinthem,becausethereisaselffulfillingprophecy.– Ifthisistheonlyreasonforthestockpricereaction,though,thereturns
arenotonlylikelytobesmallbutcouldveryquicklydissipate.• Afourstepprocesstogettingthemostoutofanalysts:
– Identifytheanalystswhoarenotonlythemostinfluentialbutalsohavethemostcontent(privateinformation).Recommendationsbackedupbynumbersandasolidstoryhavemorehefttothem.
– Screenoutanalystswherethepotentialconflictsofinterestaretoolargefortherecommendationstobeunbiased.
– Youshouldinvestbasedupontherecommendations,preferablyatthetimetherecommendationsaremade.
– Assumingthatyoustillattachcredencetotheviewsoftherecommendinganalysts,youshouldwatchanalystsforsignalsthattheyhavechangedorarechangingtheirminds.
![Page 16: INFORMATION TRADING: FOLLOWING THE ANALYSTSpeople.stern.nyu.edu/adamodar/pptfiles/invphiloh...1.27% in the week before the forecast revision, and 1.12% in the week after, and that](https://reader033.vdocuments.site/reader033/viewer/2022060223/5f07ea1b7e708231d41f6462/html5/thumbnails/16.jpg)
16
Aflatterinvestmentworld?
¨ Analystadvantageshaveshrunk:Theadvantagesthatanalystshaveoverotherinvestorshasshrunkifnotdisappearedformanyreasons:¤ Therulesoninsiderinformationhasbecomemuchmorestringentaroundthe
world,andespeciallysoinEuropeandtheUS,makingitalmostimpossibleforcompaniestopassontangibleinformationjusttoanalysts.
¤ Accesstodata(companyfilings,managementdiscussions,evenanalystreports)hasbeendemocratized.
¤ Powerfultoolsarenolongersoexpensivethatonlythelargeinstitutionscanaffordthem.
¨ Analystsplaythepricinggame:Analystsarejudgedbaseduponhowtheirrecommendationsplayoutintheshortterm,notthelongterm.Hence,theirinterestslielessinvalueandmoreinprice.
¨ Adifferentstrategy? Thefactthatthegamehasevenedoutandthatanalystsplaythepricinggamemayallowinvestorstoplayoffanalyst-drivenmispricingtomakemoney.