Can financial statement analysis beat consensus analysts’ recommendations?
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We examine whether investors can exploit financial statement information to identify companies with a greater likelihood of future earnings increases and whether stocks of those companies generate 1-year abnormal returns that exceed the abnormal returns from following analysts’ consensus recommendations. Our approach summarizes financial statement information into a “predicted earnings increase score,” which captures the likelihood of 1-year-ahead earnings increases. We find that, within our sample of consensus recommendations, stocks with high scores are much more likely to experience future earnings increases than stocks with low scores. A hedge portfolio strategy that utilizes our approach within each consensus recommendation level generates average annual abnormal returns of 10.9 percent over our 12-year sample period, after controlling for previously identified risk factors. These abnormal returns exceed those available from following analysts’ consensus recommendations. Our results show that share prices and consensus recommendations fail to impound financial statement information that helps predict future earnings changes.
KeywordsEarnings predictions Financial statement analysis Consensus recommendations Abnormal returns Sell side analysts
JEL ClassificationG10 G11 G14 G17 M41
We gratefully acknowledge helpful comments from S. Baginski, L. Bamber, M. Billings, M. Illueca, C. Nichols, the editor and reviewers, and workshop participants at the University of Georgia, Cornell University, the University of Toronto, and the BBVA Foundation—IVIE International Seminar on Accounting, Financial Institutions, and Capital Markets in Castellon-de-Plana, Spain. I/B/E/S provided analyst forecast data as part of a broad academic program to encourage earnings expectations research.
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