What Drives the Value of Analysts' Recommendations: Earnings Estimates or Discount Rate Estimates?

  • Kecskes A
  • Michaely R
  • Womack K
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alyst changes his recommendation of a stock, his valuation differs from the market's valuation based on differences in earnings estimates and/or discount rate estimates. We argue that earnings-based recommendation changes are characterized by hard information, greater verifiability, and shorter forecast horizons compared to discount rate-based recommendation changes. Therefore, earnings-based recommendation changes are less subject to analysts' cognitive and incentive biases and thus they are more informative than discount rate-based recommendation changes. Consistent with this argument, we find that investors differentiate between earnings-based and discount rate-based recommendation changes. Both the initial market reaction to and the drift after recommendation changes are twice as big for earnings-based versus discount rate-based recommendation changes. Trading on earnings-based recommendation changes earns risk-adjusted returns of over three percent per month.

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  • Ambrus Kecskes

  • Roni Michaely

  • Kent L. Womack

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