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Bridges for Sale: Finding Value in Sell-Side Estimates, Recommendations, and Target Prices

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Bridges for Sale: Finding Value in Sell-Side Estimates, Recommendations, and Target Prices

Highlights

Investors should focus on shifts in consensus recommendations, as the recommendation level by itself often reflects pro-management and high-growth biases.

Analyst estimate dispersion acts as an indicator of corporate quality – high quality companies have more stable revenue and income streams that are more amenable to forecasting.

In May 2002, the SEC approved NYSE and NASD rules designed to mitigate research analyst conflicts of interest. Among other things, the rules prohibit analyst participation in investment banking (IB) sales activities and bar them from reporting to IB departments. While not eliminating conflicts, the rules and accompanying enforcement actions have had a big effect on how research departments operate.

This report looks at the informativeness of analyst recommendation revisions, target price revisions, and estimate dispersion, primarily within the post-2002 regulatory environment, and finds significant results in all three areas.

Findings include:

  • Investors should focus on shifts in consensus recommendations versus their levels, which tend to be biased. A strategy based on the 3-month change in analyst buys vs. sells generates statistically significant results across all geographic regions.
  • Target price revisions likewise provide insight into changing analyst attitudes. The 6-month change in target price gap, or spread between target and market price, produces significant results across market cap ranges in the U.S and in international markets.
  • Analyst estimate dispersion acts as an indicator of corporate quality, as high quality companies are more amenable to forecasting. One-month revenue estimate dispersion is effective as a small cap strategy in the U.S. as well as across the indices for Europe and developed Asia.
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