The Profitability of Analysts’ Stock Recommendations: What Role Does Investor Sentiment Play?*

Abstract

This study investigates whether analysts who respond to investor sentiment issue more or less profitable stock recommendations than their peers. We find that analysts, on average, issue more favorable stock recommendations when investor sentiment is more bullish. However, analysts whose stock recommendations are positively correlated with recent or future investor sentiment tend to issue less profitable recommendations than other analysts who follow the same firm and may focus solely on fundamentals such as earnings, cash flows, and discount rates. Our results suggest that some analysts recommend stocks based, in part, on signals that may affect price but that are not theoretically related to firms' underlying intrinsic value. Thus, our results may help explain the findings of prior studies which document the failure of some analysts to fully incorporate their earnings forecasts into their stock recommendations.