Long-term Earnings Growth Forecasts Research Articles

Are Financial Analysts’ Long-Term Earnings Growth Forecasts for Loss Firms Informative to Investors?

Are Financial Analysts’ Long-Term Earnings Growth Forecasts for Loss Firms Informative to Investors?

Long-term earnings growth forecasts: investor sentiment or valuation difficulty?

PurposeThis article analyzes the hypothesis that analysts issue higher long-term earnings growth (LTG) forecasts following a market-wide investor sentiment.Design/methodology/approachThis study analyzed 193 publicly traded Brazilian firms listed on B3 (Brasil, Bolsa, Balcão), totaling 2,291 observations. To address the potential selection bias resulting from analysts' preference for more liquid firms, this study used the Heckman model in the analysis with samples with only one analyst and the entire sample. The study also applied other robustness tests to ensure the reliability of the findings.FindingsThe results suggest that market-wide investor sentiment influences LTG when the firm's stocks are difficult to value. Market optimism did not reflect five-year profit growth after the forecast issue, suggesting lower forecast accuracy during high investor sentiment values.Practical implicationsVolatile-earnings firms have relevant implications in LTG forecasts during bullish moments. According to the study’s evidence, investors' decisions and policymakers' and regulators' rules should consider analysts' expertise as independent information when considering LTG as input for valuation models, even under market optimism.Originality/valueThis paper contributes to the literature on the influence of investor sentiment on analysts' forecasts by incorporating two crucial elements in the discussion: the scenario free from herding behavior, as usually only one analyst issues LGT forecast for Brazilian firms, and the analysis of research hypotheses incorporates the difficulty of pricing a firm given the uncertainty of its earnings as an explanation to bullish forecast.

Industry-level versus firm-level forecasts of long-term earnings growth

This study assesses whether industry-level forecasts of long-term earnings growth (LTG) are more accurate than firm-level LTG forecasts commonly employed in prior work. I find that industry-level forecasts of LTG are more accurate than (i) firm-level forecasts, (ii) the median I/B/E/S consensus analyst LTG forecast, (iii) a zero growth forecast, and (iv) an LTG forecast combining industry and firm information. Industry-level forecasts are more accurate than firm-level forecasts for firms experiencing extreme growth and firms with high earnings variability, and are less accurate for firms in the Decline life-cycle stage.

The Debt-Equity Spread

We propose the debt-equity spread (DES) as a measure of the valuation gap between debt and equity at firm level. DES strongly predicts stock and bond returns in opposite directions. A strategy that takes long positions in firms with low DES, whose stocks are cheap relative to bonds, and short those with high DES generates an average stock return of 6% per annum and bond return of -3.3% per annum. The return predictability is consistently stronger among small, illiquid, and difficult-to-short stocks and bonds. In addition, higher debt-equity spreads are associated with (i) higher probability for negative revision of long-term earnings growth forecasts; (ii) more equity issuance and debt repurchase, resulting in a low leverage ratio; (iii) stronger preferences for stock payments in acquisitions; and (iv) more insider stock selling. Together, these results suggest that the return prediction of DES is likely driven by mispricing rather than risk exposures.

The Issuance and Informativeness of Management Long-Term Earnings Growth Forecasts

SYNOPSISThis study examines quantitative long-term earnings growth (LTG) forecasts issued by publicly traded firms. While the difficulty of verifying management LTG forecasts provides incentives for self-serving disclosures, we find that stakeholder interests and forecast credibility considerations significantly constrain such tendencies. In particular, we find that demand from market participants, information asymmetry, peer LTG forecast provision, product market competition, and industry profitability drive management LTG forecast issuance, while poor performance and high uncertainty over firm growth prospects deter management LTG forecast issuance. Moreover, we provide evidence that management LTG forecasts, on average, provide incremental information about future earnings growth, and that high competition and investor monitoring increase LTG forecast informativeness, consistent with predictions of theoretical cheap talk models. Our findings also indicate that both upward and downward LTG guidance provide incremental information about future earnings growth, and that analysts revise their LTG forecasts in the direction of LTG guidance. Overall, our study contributes to the voluntary disclosure literature by providing evidence that suggests elements of a firm's disclosure environment significantly influence the issuance and informativeness of difficult-to-verify disclosures.JEL Classifications: C23; D81; D82; M41.

Analysts' Stock Recommendations, Earnings Growth and Risk

A key output of sell-side analysts is their recommendations to investors as to whether they should, buy, hold or sell a company's shares. However, relatively little is known regarding the determinants of those recommendations. This study considers this question, presenting results that suggest that recommendations are dependent on analysts’ short-term and long-term earnings growth forecasts, as well as on proxies for the analysts’ unobservable views on earnings growth in the more distant future and risk. Furthermore, analysts who appear to incorporate earnings growth beyond the long-term growth forecast horizons and risk into their recommendation decisions make more profitable stock recommendations.

Analysts' Reluctance to Voice Conservative Opinions and the Informational Value of Long-term Earnings Growth Forecasts

In explaining the poor informational value of analysts’ long-term earnings growth forecasts, studies have focused on the excessively aggressive forecasts induced by analysts’ incentives and/or cognitive biases. This study reveals that forecasts’ poor informational value is driven by analysts’ reluctance to issue conservative forecasts, which may also be induced by their incentives and/or biases. We predict that this reluctance allows each firm’s conservative forecast to be influenced by the firm’s past performance and the noisy predictors of high-growth firms. Consistent with our prediction, we find that each firm’s most conservative forecasts are those most strongly influenced by past performance and have the least predictive power.

Analystss Reluctance to Voice Conservative Opinions and the Informational Value of Long-Term Earnings Growth Forecasts

The extant research indicates that analysts’ long-term earnings growth forecasts are especially optimistic for past winners, and have little predictive power to distinguish between high-growth and low-growth firms. In explaining the poor informational value of analysts’ long-term earnings growth forecasts, studies have focused on the excessively aggressive forecasts induced by analysts’ inflation of their true beliefs. This study reveals that the forecasts’ poor informational value is driven by analysts’ reluctance to voice conservative opinions rather than analysts’ inflation of their true beliefs. We predict that this reluctance allows each firm’s conservative forecast to be heavily influenced by the firm’s past performance and allows the noisy predictors to distinguish high-growth firms from low-growth ones. Consistent with our prediction, we find that each firm’s most conservative forecasts are those most strongly influenced by past performance and have the least predictive power.

Market implied future earnings and analysts’ forecasts

This study provides evidence on market implied future earnings based on the residual income valuation (RIV) framework and compares these earnings with analyst earnings forecasts for accuracy (absolute forecast error) and bias (signed forecast error). Prior research shows that current stock price reflects future earnings and that analyst forecasts are biased. Thus, how price-based imputed forecasts compare with analyst forecasts is interesting. Using different cost of capital estimates, we use the price-earnings relation and impute firms’ future annual earnings from three residual income (RI) models for up to 5 years. Relative to I/B/E/S analyst forecasts, imputed forecasts from the RI models are less or no more biased when cost of capital is low (equal to a risk-free rate or slightly higher). Analysts slightly outperform these RI models in terms of accuracy for immediate future (1 or 2) years in the forecast horizon but the opposite is true for more distant future years when cost of capital is low. A regression analysis shows that, in explaining future earnings changes, analyst forecasts relative to imputed forecasts do not impound a significant amount of earnings information embedded in current price. In additional tests, we impute future long-term earnings growth rates and find that they are more accurate and less biased than I/B/E/S analyst long-term earnings growth forecasts. Together, the results suggest that the RIV framework can be used to impute a firm’s future earnings that are high in accuracy and low in bias, especially for distant future years.

Analyst Conflicts and Research Quality

This paper examines whether the quality of stock analysts' forecasts is related to conflicts of interest from their employers' investment banking (IB) and brokerage businesses. We consider four aspects of forecast quality: accuracy, bias, and revision frequency of quarterly earnings per share (EPS) forecasts and relative optimism in long-term earnings growth (LTG) forecasts. Using a unique dataset that contains the annual revenue breakdown of analysts' employers among IB, brokerage, and other businesses, we uncover two main findings. First, accuracy and bias in quarterly EPS forecasts appear to be unrelated to conflict magnitudes after controlling for forecast age, firm resources, and analyst characteristics. Second, relative optimism in LTG forecasts and the revision frequency of quarterly EPS forecasts are positively related to the importance of brokerage business to analysts' employers. Additional tests suggest that the frequency of quarterly forecast revisions is positively related to analysts' trade generation incentives. Our findings suggest that reputation concerns keep analysts honest with respect to short-term earnings forecasts but not LTG forecasts. In addition, conflicts from brokerage appear to play a more important role in shaping analysts' forecasting behavior than has been previously recognized.

Do Financial Analysts’ Long-Term Growth Forecasts Matter? Evidence from Stock Recommendations and Career Outcomes

Prior literature refers to economic incentives to generate investment banking business and trading commissions as explanations for analyst publication of forecasts of firms’ long-term earnings growth (LTG). Prior research also documents wildly optimistic LTG forecasts and a negative relation between LTG forecasts and subsequent excess returns. Thus, the literature portrays analysts’ LTG forecasts as nonsensical from a valuation perspective. We introduce and investigate a new perspective on the value-relevance of analyst publication of LTG forecasts. We hypothesize that analysts issuing LTG forecasts signal relatively high effort and ability in developing perspective of the subject firms’ long-term prospects. Consistent with this hypothesis, we find that the stock market responds more strongly to the stock recommendation revisions of analysts who publish accompanying LTG forecasts. In addition, we hypothesize and find that analysts issuing LTG forecasts are less likely to leave the profession or move to smaller brokerage houses. Consistent with Reg. FD’s intention to restrict analyst access to insider information and promote fundamental analysis of the valuation implications of firms’ long-term prospects, we find that post-Reg. FD observations drive most of our results. Overall, we identify previously undocumented benefits accruing to analysts who publish LTG forecasts.

The disparity between long-term and short-term forecasted earnings growth

We find the disparity between long-term and short-term analyst forecasted earnings growth is a robust predictor of future returns and long-term analyst forecast errors. After adjusting for industry characteristics, stocks whose long-term earnings growth forecasts are far above or far below their implied short-term forecasts for earnings growth have negative and positive subsequent risk-adjusted returns along with downward and upward revisions in long-term forecasted earnings growth, respectively. Additional results indicate that investor inattention toward firm-level changes in long-term earnings growth is responsible for these risk-adjusted returns.

Long-Term Earnings Growth Forecasts, Limited Attention, and Return Predictability

Long-term earnings expectations are critically important to stock price valuations. We identify relative optimism and relative pessimism in long-term analyst forecasts by comparing these forecasts with implied short-term earnings growth forecasts across firms within the same industry. Stocks with relatively optimistic and relatively pessimistic long-term analyst forecasts have negative and positive risk-adjusted returns, respectively. This return predictability depends critically on short-term forecasts since relative optimism and relative pessimism originate from the slow diffusion of information from short-term to long-term analyst forecasts. Our results indicate that market participants have limited attention regarding the long-term earnings implications of information.

Do Analysts’ Long-Term Growth Forecasts Signal Effective Effort Underlying Informative Stock Recommendations and Favorable Career Outcomes?

Prior literature finds that economic incentives related to generating investment banking business and trading commissions provide the most dominant explanation for variation in analysts’ forecasts of firms’ long-term earnings growth (LTG). Prior research evidence also indicates that relying on LTG forecasts leads to negative excess returns in subsequent periods. However, the literature also documents that analysts’ LTG forecasts explain variation in their own stock recommendations. These results beg the question as to why analysts issue and use LTG forecasts that apparently fail to enhance the value-relevance of their stock recommendations. This paper addresses that question by examining whether the issuance of LTG forecasts reflects analyst effort that does, indeed, enhance the value-relevance of their stock recommendations. We show that analysts who publish LTG forecasts provide the market with more timely stock recommendations. We also find that the stock market responds more strongly to stock recommendations and recommendation revisions accompanied by LTG forecasts issued by the same analysts. Further tests show that post- Regulation Fair Disclosure (Reg. FD) observations drive our results. Finally, we investigate the effect of LTG forecast issuance on analyst career outcomes and find evidence suggesting that analysts issuing LTG forecasts are less likely to leave the profession or move to smaller brokerage houses, particularly after Reg. FD. Overall, our results suggest that publication of LTG forecasts signals effective effort increasing the value-relevance of analysts’ recommendations and providing more job security.

Divergence of Opinion, Overallotment, and IPO Long-Run Performance

We apply an ex ante measure of divergence of investor opinions – industry-level dispersion in analyst earnings forecast – to test the Miller (1977) prediction about IPO overvaluation. Our measure of divergence of opinion is the dispersion in analyst long-term earnings growth forecasts divided by the absolute value of the mean long-term growth forecast averaged at the industry level in the month prior to the IPO. We focus on the effect of divergence of opinion on long-run IPO performance, and test two hypotheses. First, greater divergence of opinion should predict lower long-run performance. Second, since the Miller effect depends on the demand of the offer relative to the supply, we further predict that the effect of belief dispersion should be stronger for offers with high investor demand, as measured by issue overallotment at the time of the offer. Using a sample of about 7,000 IPOs from 1982 to 2005, we find that IPOs in industries with high divergence of opinion have lower long-run returns in the following 3-5 years than IPOs in industries with low divergence of opinion. The effect of belief dispersion on long-run performance primarily exists among IPOs with high demand, as measured by the overallotment at the time of the offer, and this effect remains strong when returns are value-weighted. These findings support Miller’s hypothesis that in markets with restricted short-selling, valuations reflect the most optimistic investor’s appraisal in the short-run, and the initial overvaluation is corrected in the long-run. There is evidence that IPOs with high divergence of opinion also have lower first-day returns, but this association is weakened by the amount of overallotment, suggesting that the correction of initial overvaluation starts shortly after the offer, but the initial correction is dampened by investor demand at the time of the offer.

The Disparity between Long-Term and Short-Term Forecasted Earnings Growth

We find the disparity between long-term and short-term analyst forecasted earnings growth is a robust predictor of future returns and revisions in long-term forecasted earnings growth. After adjusting for industry characteristics, stocks whose long-term earnings growth forecasts are far above or far below their implied short-term forecasts for earnings growth have negative and positive subsequent risk-adjusted returns, respectively. Despite the importance of conditioning on short-term forecasted earnings growth, these returns are not driven by earnings momentum. Instead, consistent with investors having limited attention, predictable revisions in long-term analyst forecasts appear to induce return predictability.

Does Affiliation Bias Analyst Long-Term Earnings Growth Forecasts?

We study long-term earnings growth (LTG) forecasts around seasoned equity offerings. We document that LTG forecasts for firms with fewer analysts are generally higher than forecasts for firms with more analysts covering the stock. In contrast to prior studies, we find no difference between LTG forecasts of affiliated analysts who work for investment banks that have relationships with equity issuing firms and those of unaffiliated analysts. Further analysis shows that aggregation bias influences the prior studies' conclusion that affiliated analysts make more optimistic LTG forecasts. Both affiliated and unaffiliated analyst forecasts are more optimistic for firms with fewer analysts. In addition, the number of unaffiliated analysts relative to the number of affiliated analysts covering the same firm increases with the firm's analyst coverage. As a result, the mean forecast bias of unaffiliated analysts turns out to be lower than the mean forecast bias of affiliated analysts. However, this observed difference in mean forecast bias is driven by analyst coverage rather than analyst affiliation.

Do Financial Analysts’ Long-Term Growth Forecasts Reflect Effective Effort Towards Informative Stock Recommendations?

Prior literature finds that economic incentives related to generating investment banking business and trading commissions dominate explanations for the variation in analysts’ forecasts of firms’ long-term earnings growth (LTG) and, therefore, LTG forecasts provide little, if any, insight into the real growth prospects and current valuation of a firm’s equity securities. However, it is puzzling why stock analysts issue long-term growth forecasts that bear no relation to their effort in formulating stock recommendations that identify mispriced securities. This paper attempts to address this puzzling, but interesting question by examining whether the issuance of LTG forecasts reflects analyst effort that enhances the value-relevance of their stock recommendations. We show that the stock market responds more strongly to recommendation revisions by analysts who also issue LTG forecasts, and investors following the stock recommendations of analysts issuing LTG forecasts earn more trading profits than investors relying on the recommendations of analysts not issuing LTG forecasts. Our results suggest that analysts’ LTG forecasts reflect effective effort to increase the value-relevance of stock recommendations. Finally, we investigate the effect of LTG forecast issuance on analyst career outcomes and find that analysts issuing LTG forecasts are less likely to be demoted or terminated. Thus, analysts’ effort to issue LTG forecast and effective application of LTG in making recommendations are rewarded with higher job security.

The Existence and Value-Relevance of Financial Analysts' Long-Term Growth Forecasts*

This paper investigates two questions. First, why do we observe analysts’ long-term earnings growth forecasts (hereafter, LTG forecasts) for some firms but not others and why do some analysts issue LTG forecasts while others do not? Second, are the LTG forecasts viewed as value-relevant by investors and do they enhance the value-relevance of stock recommendations? For the first question, at the firm level, we predict a positive (negative) relation with investors’ demand for LTG forecasts (the cost of collecting long-term oriented information). In particular, we hypothesize that the existence of LTG forecasts increases with the firm’s growth opportunities, the firm’s financial health, the proportion of shareholdings by long-horizon investors, firm size, and firm age and decrease with loss occurrence. At the analyst level, we predict that analysts with less time and resource constraints, with more experience and ability, and inputting more research effort in covering a firm are more likely to issue LTG forecasts. Empirical results are largely consistent with our predictions. For the second question, we find that the stock market responds significantly to LTG forecast revisions. In addition, the stock market responds more strongly to recommendation revisions by analysts who also issue LTG forecasts. Further, investors following the stock recommendations of analysts issuing LTG forecasts earn more trading profits than investors relying on the recommendations of analysts not issuing LTG forecasts.

The Effect of Firms' Voluntary Earnings Growth Guidance on Analysts' Long-Term Earnings Growth Forecast Performance*

The Effect of Firms' Voluntary Earnings Growth Guidance on Analysts' Long-Term Earnings Growth Forecast Performance*