Do Accurate Earnings Forecasts Facilitate Superior Investment Recommendations?

We carefully construct measures of earnings forecast accuracy and recommendation profitability that enable us to examine the association between the qualities of these two key outputs of individual security analysts. We find that analysts with superior earnings forecasts issue significantly more profitable recommendations than those with less accurate forecasts. The average annual recommendations return of top one-third analysts sorted on forecast accuracy exceeds that of the bottom third by 10.8% during our sample period. Our results suggest that imperfectly efficient markets allow information gatherers like security analysts to be rewarded for their costly activities. Our findings also provide direct empirical support for the recent “valuation” models in accounting and finance literature (Ohlson (1995) and others) that emphasize the role of future earnings in predicting stock price movements.