Evidence on Analyst Stock Recommendations, Cash Flow Valuations, and Stock Return Profitability

Abstract

This paper examines whether analysts’ stock recommendations are informed by their cash flow forecasts, and whether these recommendations and cash flow forecasts provide investors with useful information to identify mispriced securities. In doing so, the paper contributes to the ongoing debate regarding the sophistication and value of analysts’ cash flow forecasts. Our findings show that analysts’ stock recommendations are informed by their cash flow forecasts when their forecasts are used in simple cash flow valuation heuristics. However, using these recommendations and heuristics to identify mispricing fails to earn investors excess returns. In contrast, we show that buy-and-hold investors earn significant excess returns by identifying mispricing using analysts’ cash flow forecasts in a discounted valuation model. Overall, we provide the first empirical evidence to suggest that, while analysts apparently fail to use their cash flow forecasts in a sophisticated valuation model, investors can use these forecasts in this manner to identify mispriced securities to earn significant excess returns.