The association of analysts’ cash flow forecasts with stock recommendation profitability

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PurposeThe purpose of this paper is to examine whether analysts’ cash flow forecasts improve the profitability of their stock recommendations and whether the positive effect of cash flow forecasts on analysts’ stock recommendation performance varies with firms’ earnings quality.Design/methodology/approachTo test the authors’ predictions, they identify a sample of 161,673 stock recommendations with contemporaneous earnings forecasts and/or cash flow forecasts and regress market-adjusted stock returns on a binary variable that proxies for the issuance of cash flow forecasts while controlling for contemporaneous earnings forecast accuracy, earnings quality, analysts’ forecast experience and capability and certain firm characteristics. The authors’ test results are robust to alternative measures of recommendation profitability, earnings quality and the use of recommendation revisions instead of recommendation levels.FindingsThe authors find that when analysts issue cash flow forecasts concurrently with earnings forecasts, their stock recommendations lead to higher profitability than when they only issue earnings forecasts, after controlling for analysts’ forecast capability. Moreover, the authors document that the contemporaneous positive relationship between cash flow forecasts and recommendations profitability is stronger for firms with low earnings quality than for firms with high earnings quality. The findings suggest that cash flow forecasts issued by analysts in response to market demand likely play a more important role in firm valuation than cash flow forecasts issued by analysts mainly because of supply-side considerations.Research limitations/implicationsFuture research could build on these findings to conduct further investigation on the alternative incentives for analysts’ forecasts of sales growth and long-term growth rates.Practical implicationsThese findings may also help investors to better assess the quality of analysts’ research outputs and to identify superior stock recommendations.Originality/valueThis study provides insight into the role of cash flow forecasts in firm valuation and adds fresh evidence to the debate on the usefulness of cash flow forecasts. It extends the stream of research on the characteristics of analyst forecasts and increases our knowledge about the role of analysts in the financial market.