Usefulness of Non-U.S. Analyst Stock Recommendations and Earnings Forecasts

Are stock recommendations and earnings forecasts from analysts in markets outside the U.S. useful to investors? In their February 2009 paper entitled “International Evidence on Analyst Stock Recommendations, Valuations, and Returns”, Ran Barniv, Ole-Kristian Hope, Mark Myring and Wayne Thomas examine the usefulness of non-U.S. analyst outputs by testing relationships between: (1) valuation estimates and stock recommendations; (2) valuation estimates and future excess returns; and, (3) stock recommendations and future stock returns. They segment results according to level of investor legal protection within the analyst’s country, as indicated by assessments of rule of law, judicial system efficiency and corruption. Using earnings forecasts, stock recommendations and monthly stock return data for 30 countries over the period January 1993 to May 2007, they conclude that:

• On a scale of 1 (Strong Sell) to 5 (Strong Buy), the average recommendation over the entire sample is about 3.5.
• Over the entire sample and especially for analysts in countries with strong investor legal protection:
  • Residual income valuations based on analyst earnings estimates relate positively to future stock returns.
  • Residual income valuations based on analyst earnings estimates relate negatively to analyst stock recommendations. Analysts appear to rely on simple indicators rather than formal valuations based on their own earnings estimates in making recommendations.
  • Analyst stock recommendations relate negatively to future stock returns.
• However, analysts in countries with weak investor legal protection rely more on residual income valuation estimates in making stock recommendations, and this subset of recommendations relates positively to future stock returns.
• Relative correlations suggest that analyst earnings forecasts (when used for residual income valuation) are more useful than stock recommendations in strong investor protection countries, but analyst stock recommendations are more useful in weak investor protection countries.
• Findings are consistent with the ostensibly perverse conclusion that incentives other than accuracy in stock recommendations have decisive influence on analysts in strong investor protection countries, where investors have good legal recourse.

In summary, investors should generally focus on the earnings estimates rather than the stock recommendations of equity analysts around the globe. Stock recommendations may offer incremental value (only) in countries with weak legal systems.

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