Analysts, Industries, and Price Momentum

Abstract

The information value of analysts' recommendations is particularly enhanced by taking an industry perspective. Three benefits emerge. First, we show that analyst recommendation changes provide signals that can be used to successfully rank future relative underperforming and outperforming stocks within industries. When this ranking is used to form industry-neutral portfolios, the return-to-risk ratio improves almost 100% relative to portfolios in which industry weighting is ignored. The value of analyst recommendation signals, examined with the industry perspective, is remarkably consistent through time. Industry-neutral portfolio Sharpe ratios are six times larger than those of typical price momentum strategies. Second, examining recommendation information by industry permits the disentanglement of the value added by analysts from the well-documented price momentum anomaly. Equal-industry-weighted recommendation portfolios have greatly reduced loadings on price momentum relative to un-weighted strategies. Third, the industry perspective permits an examination of the link between analyst recommendation information, aggregated at the industry level, and industry returns. Industry returns precede industry-aggregated analyst information in the next month, suggesting that analysts take strong cues from recent industry returns in revising their opinions on stocks they follow. Perhaps more interestingly, however, we do not find that industry-aggregated analyst recommendation information predicts future relative underperforming and outperforming industries in any meaningful, incremental way.