PROFITABILITY OF ANALYSTS’ STOCK RECOMMENDATIONS EVIDENCE FROM UNITED KINGDOM

Abstract

Sell-side security analysts have often found themselves under the constant scrutiny of both the media and academe due to one popular question. Can they offer useful investment advices? This paper aims to answer this question, by providing a comprehensive analysis of the investment value of analysts’ stock recommendations – the Buy, Sell or Hold prognoses that are most distinct of analysts’ research outputs. We base our study on comprehensive recommendations data in UK, where extant literature in this area is thin. Using an investor-oriented, calendar-time framework, this study empirically measures the profitability of investment strategies that are formed based on analyst consensus recommendations. In addition, it extends the current literature by analysing the effect of firm size and forecast dispersion on the usefulness of these recommendations. Our results indicate that purchasing (selling-short) the most (least) recommended stocks, in conjunction with an equal-weighted investment strategy, yield significant marketadjusted returns. We show that firm size is an important determinant of the success of this strategy, because analysts provide more useful recommendations for smaller firms. We also find some negative association between dispersion in analysts’ earnings forecasts and the profitability of consensus recommendations. By interpreting forecast dispersion as a proxy for the level of disagreement among analysts, we argue that our finding is a result of less useful consensus recommendations when disagreement is high. Finally, we also document that a strategy which invests based on changes in consensus recommendations is significantly profitable. Our findings, in essence, provide compelling evidence of the investment value of analysts’ stock recommendations.