28 December 2009 – Chart of the Week

Chart of the Week: The Impact of Analyst Earnings Revisions on the Market

At least over the short run, analyst earnings revisions are “information-free,” according to new academic research.

In their recent paper presented at the American Finance Association, Oya Altinkiliç and two colleagues dissected over six million earnings forecasts from FirstCall’s database between 1997 and 2007. The professors split the revisions into three categories: significant upward changes of at least 5%, downward revisions of at least 5%, and the rest. They then examined the stock price performance in the two days before and the two days after the announcement of each forecast revision.

The professors found that large upward revisions were preceded by large stock price movements. Once the earnings revision was announced, the stock price moved only marginally. In other words, the stocks that they upgraded had already gone up and analysts appeared to be reacting to an event that the market was already pricing in. Large downward revisions likewise followed a sharp drop in stock prices. The study involves a far more rigorous methodology but their bottom line is that “analyst forecasts generally reiterate public information that is already accounted for in stock prices, and they rarely produce new information that impacts stock prices.”

The researchers leave open the possibility that analysts might fulfill other functions that contribute to the efficiency of the market. They also leave unexplored the longer-term dynamics of major disruptions to market equilibrium that can take far longer than a few days to play out in stock prices and analyst earnings models. However, their findings do suggest that the latest earnings revision on its own is unlikely to yield many alpha opportunities. The FT has a fuller summary and the entire paper is available for download at SSRN.

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