Does Analyst Optimism About Future Earnings Distort Stock Prices?
Abstract (Via JBF)
Monthly returns to firms with optimistic expectations are 1.5% lower versus firms with pessimistic expectations, while annual buy-and-hold returns to firms with optimistic expectations are 20% lower. The optimistic component of stock prices lingers months after the optimism is revealed to the market. It also exists separately from the component related to analyst forecast dispersion. The possibility that forecast dispersion is related to transitory versus permanent earnings is proposed.
Introduction (Via JBF)
Several recent studies find that analyst earnings forecast properties are related to stock returns.1 Firms with low dispersion or low error outperform firms with high dispersion or high error. Some researchers believe that firms with highly dispersed forecasts tend to reflect the views of optimistic investors who are subsequently disappointed, causing these firms to suffer persistently low stock returns. Another possibility is that firms with losses have returns that are different from firms with profits (e.g., Ettredge and Fuller ). Loss firms are associated with overwhelmingly optimistic forecasts and low transparency levels (Ciccone ).
Purpose (Via JBF)
The purpose of this study is to examine the relation between optimistic expectations and stock returns. The testing analyzes three central issues: 1) the extent to which optimism is a component of stock returns, 2) the relation between any optimism component of stock returns and analyst forecast properties, and 3) the relation between any optimism component of stock returns and losses.
Findings (Via JBF)
The results demonstrate that investor optimism is reflected in stock prices. As the investors become disappointed, the stock returns are significantly lower than firms without such expectations. Thus, investor sentiment and behavior does appear to play an important role in the stock market. Optimism does not interact with analyst forecast properties in affecting stock returns. The relation between optimism and stock returns is also unaffected by losses.