Why Does Analyst Forecast Dispersion Predict Stock Return? A Corporate Guidance Perspective

Several studies find that stocks with higher dispersion of analysts’ earnings forecasts have lower future returns. The phenomenon is popularly interpreted as evidence that stock prices reflect optimism in the presence of differences of opinions and short-sales constraints. This paper shows that stocks with higher forecast dispersion also experience poorer operating performance in the future. We provides an alternative explanation consistent with empirical patterns in both operating performance and stock market reaction. In our model, analyst forecast dispersion is endogenously determined by corporate earnings guidance strategies; further, firms with better earnings prospects provide more accurate earnings guidance, leading to less dispersed analysts forecasts. Further empirical analysis supports this explanation.