Do Brokerage Analysts' Recommendations Have Investment Value? KENT L.

WOMACK [1996]

Siraprapa Watakit 5502310013

Agenda
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Overview of The Paper Contribution I. Data, Sample Selection, and Sample Description II. The Event-Period Market Reactions to Recommendation Changes III. Post-Recommendation Drift V. Conclusion and Summary

Overview of The Paper

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The paper study event that is rarely study at that time(1996) such event are market reaction towards buy/sell recommendations Other previous event studies conclude that recommendation from analyst has no abnormal return Such claims are critiques for sample bias To study this topics, Womack uses First Call database of 14 Top RankedUS Brokerage firms then analyst the event in short-term and long-term period price increases for buy recommendation and decreases sell recommendation There is also post recommendation price drift in the analyst forecasted direction

Contribution
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The study consist of the analysis of short-term and long-term return/perfomance Using new source of data, the paper provide a new evidence on stock price formation and the ability of analysts to predict/influent the stock price Analyst appear to have market timing and stock picking ability There exists a drift in the market after buy/sell recommendation event

What does analyst do?

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By job description, analyst primarily services to investors are #1: Provide timing BUY/SELL recommendations #2:Analyst and predict company future prospects Analyst will add stock to buy-list if she/he thinks it is undervalue and remove from buy-list if she/he thinks it is overvalue if the recommendation has value, that is investor can gain abnormal return, the analyst should be rewarded with commissions charges

I. Data, Sample Selection, and Sample Description

Source: First Call realtime-database Selection:14 top ranked US brokerage firmss Daily recommendation, commentary of portfolio strategies and etc. The data also comes with specific date and approximate time. There are many recommendation and changes in recommendation in the database(150,000 during 1989-1991) but only 4 extreme case is include in this study 1) added-to-buy, 2)re-moved-from-buy, 3) added-to-sell and 4) removed-from-sell. Final sample 1573 observation in the study

I. Data, Sample Selection, and Sample Description

Large Cap firm got recommended most

Buy to Sell recommend is 7:2

I. Data, Sample Selection, and Sample Description

Consistent with underpriced vs. overpriced hypothesis e.g. for the stock that is too cheap, we would expect low PE value..12.5x vs. 13.0x

average %changes in mean 1month before and after is also consistent with the hypothesis

6M excess-return prior to recommendation is an Indirect evidence of predictive ability (some sig, some not)

II. The Event-Period Market Reactions to Recommendation Changes

Each recommendations are careful reviewed and approved by committees Important source of new information is earning release; but only 9% of new buy coincide with quarterly earning report 14% of remove from buy coincide with quarterly earning report The added-to recommendation are not driven by new information but rather the market and industry valuation model

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A. The Recommendation Event-Period Reaction

The excess return are calculated using 3 models Firm size adjusted excess return:

Portfolio size adjusted excess return

Industry size adjusted excess return

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A. The Recommendation Event-Period Reaction

Fama French excess return in last column

For a performance longer than 1 month, use these models

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A. The Recommendation Event-Period Reaction

Short-Run average excess return and volume using Brown and Warner(1985) market model

It is can be seen from the figure that there is a market reaction after the recommendation

B. Comparison with Other Events

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Table III The results of the first 3 columns are consistent with Fama French results in the last column. Compare with other event study e.g. merging, take-overs and etc., the direction is the same but the magnitude is larger

III. Post-Recommendation Drift

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Figure 2 Long-Run cumulative average excess return It can be seen that there is a drift in every type of recommendation Table 4 reinforce the msg in Table 3 that there is post-event excess return but for add-to-buy is sig at 3M, add-to-sell is sig at 6M reason: firm relectant to issue sell recommend

III. Post-Recommendation Drift

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Figure 3. Long-run average size-adjusted returns for buy and sell recommendation changes stratified by size (market capitalization deciles).

Conclusion
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Do Brokerage Analysts' Recommendations Have Investment Value?

YES, Brokerage recommendation have influence on the market prices, add-to-buy adjust the price up to 5%, while add-to-sell adjust the price down by 11% Mostly large firm are the target of analysis, the ratio of buy-tosell is 7:1 For 6M-Prior, add-to-buy/sell mean return is not significant but the remove-from-buy/sell is sig 3-Day event mean return is large and significant

Conclusion
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Post recommendation is not mean reverting but are significant and indirection forecast by analyst the market reaction for add-to-buy and add-to-sell is asymmetric