CAN INVESTORS PROFIT FROM THE PROPHETS?

CONSENSUS ANALYST RECOMMENDATIONS AND STOCK RETURNS

Brad Barber
Graduate School of Management
University of California, Davis

Reuven Lehavy
Haas School of Business
University of California, Berkeley

Maureen McNichols
Graduate School of Business
Stanford University

and

Brett Trueman
Haas School of Business
University of California, Berkeley

First Draft: August 1998

Please do not cite without permission.

We thank Zacks Investment Research for providing the data used in this study. Lehavy and
Trueman also thank the Center for Financial Reporting and Management at the Haas School of
Business for providing research support. All remaining errors are our own.
 ABSTRACT

In this paper we document that an investment strategy based on the consensus (average)

recommendations of security analysts earns positive returns. For the period 1986-1996, a

portfolio of stocks most highly recommended by analysts earned an annualized geometric mean

return of 18.8 percent, while a portfolio of stocks least favorably recommended earned only 5.78

percent. (In comparison, an investment in a value-weighted market index earned an annualized

geometric mean return of 14.5 percent.) Alternatively stated, purchasing stocks most highly

recommended by analysts and selling short those least favorably recommended yielded a return of

102 basis points per month. The magnitude of this return is surprisingly large, and is far greater

than the size effect (negative 16 basis points) and book-to-market effect (17 basis points) for the

same period. Even after controlling for these two effects, as well as for price momentum, we

show that the strategy of purchasing stocks most highly recommended and selling short those

least favorably recommended yielded a return of 75 basis points per month. These results are

robust to partitions by time period and overall market direction, and are most pronounced for

small and medium-sized firms. The abnormal returns also persist when we allow a lapse of up to

15 days before acting on the investment recommendations. There is no extant theory of asset

pricing that explains these results.

 CAN INVESTORS PROFIT FROM THE PROPHETS?
CONSENSUS ANALYST RECOMMENDATIONS AND STOCK RETURNS

INTRODUCTION

This study examines whether the publicly available recommendations of security analysts

have investment value. Academic theory and Wall Street practice are clearly at odds regarding

this issue. On the one hand, the semi-strong form of market efficiency posits that investors cannot

trade profitably on the basis of publicly available information, such as analyst recommendations.

On the other hand, research departments of brokerage houses spend billions of dollars annually on

security analysis, presumably because these firms believe it can generate superior returns for their

clients.1

These observations provide a compelling empirical motivation for our inquiry and

distinguish our analysis from many recent studies of stock return anomalies.2 In contrast to many

of these studies, which focus on corporate events, such as stock splits, or firm characteristics,

such as recent return performance, that are not directly tied to how people invest their money, we

analyze an activity security analysis that is undertaken by investment professionals at

hundreds of major brokerage houses with the express purpose of improving the return

performance of their clients.

Our results provide surprisingly strong evidence that Wall Street may be right. For the

sample period of 1986-1996 we find that buying the stocks with the most favorable consensus

1
In recent years statistics on consensus (average) analyst recommendations have become widely available on
many Internet web sites as well as on the databases of several investment information providers. See, for example,
CBSMarketWatch, at http://cbs.marketwatch.com, and the Dow Jones Retrieval Service. The consensus analyst
recommendation data usually comes from either First Call or Zacks Information Research.
2
See Fama (1998) for a review and critique of this body of work.

1
(average) recommendations earned an annualized geometric mean return of 18.8 percent, while

buying those with the least favorable consensus recommendations earned only 5.78 percent. As a

benchmark, during the same period an investment in a value-weighted market portfolio earned an

annualized geometric mean return of 14.5 percent. Alternatively stated, the most highly

recommended stocks outperformed the least favorably recommended ones by a strikingly large

102 basis points per month. In comparison, over the same period the book-to-market effect was a

mere 17 basis points, while the size effect was a negative 16 basis points per month.3

After controlling for market risk, size, and book-to-market effects using the Fama-French

three-factor model, a portfolio comprised of the most highly recommended stocks provided an

average annual abnormal return of 4.2 percent while a portfolio of the least favorably

recommended ones yielded an average annual abnormal return of -7.6 percent.4 Consequently,

purchasing the securities in the top portfolio and selling short those in the lowest portfolio yielded

an average annual abnormal return of 11.8 percent. Our results are robust to partitions by time

period and overall market direction. They are most pronounced for small and medium-sized

firms; among the few hundred largest firms we find no reliable differences between the returns of

those most highly rated and those least favorably recommended. Our results also persist when we

allow a lapse of up to 15 days before acting on the analysts recommendations. As such, our

results provide strong positive evidence in the debate over whether security analysts

3
The size and book-to-market effects were calculated using portfolios constructed by Fama and French (1993).
4
Other return models give similar results.

2
recommendations have investment value.5

These returns are gross of transaction costs, such as the bid-ask spread, brokerage

commissions, and the market impact of trading. As we show, investing in highly recommended

securities requires an active trading strategy with turnover rates at times in excess of 400 percent

annually. After a reasonable accounting for transaction costs, active trading strategies based on

the recommendations of analysts cannot reliably beat a market index. Nevertheless, the consensus

recommendations remain valuable to investors who are otherwise considering buying or selling;

ceteris paribus, an investor would be better off purchasing shares in firms with more favorable

consensus recommendations and selling shares in those with less favorable consensus

recommendations.

Our analysis represents the most comprehensive study to-date of the investment

performance of analysts recommendations. Using the Zacks database for the period 1985-1996,

which includes over 360,000 recommendations from 269 brokerage houses and 4,340 analysts,

we track in calendar time the investment performance of portfolios of firms grouped according to

their consensus analyst recommendations. Every time an analyst is reported as initiating

coverage, changing his or her rating of a firm, or dropping coverage, the consensus

recommendation of the firm is recalculated and the firm moves between portfolios, if necessary.

Any required portfolio rebalancing occurs at the end of the trading day. This means that investors

are assumed to react to a change in a consensus recommendation at the close of trading on the

5
Among the papers which previously examined the investment performance of security analysts stock
recommendations are Barber and Loeffler (1993), Bidwell (1977), Diefenbach (1972), Groth, Lewellen, Schlarbaum,
and Lease (1979), Stickel (1995), and Womack (1996). Copeland and Mayers (1982) studied the investment
performance of the Value Line Investment Survey while Desai and Jain (1995) analyzed the return from following
Barrons annual roundtable recommendations.

3
day that the change took place. Consequently, any return that investors might have earned from

advance knowledge of the recommendations is excluded from the return calculations.

Our study is most closely related to Stickel (1995) and Womack (1996). Using the Zacks

database, Stickel studies the price impact of 16,957 changes in analyst recommendations over the

1988-1991 period. He finds that recommendation changes from sell to buy (buy to sell) were

accompanied by positive (negative) returns at the time of the announcement. Further, he

documents that most of the price adjustment occurred during the first 30 days after the

recommendation change. Using the First Call database, Womack analyzes the impact of 1,573

changes in analyst recommendations to or from strong buy or strong sell, for the top 14 U.S.

brokerage research departments during the 1989-1991 period. He finds significantly positive

(negative) returns for the buy (sell) recommendations at the time of the announcement. He also

documents a post-recommendation stock price drift lasting up to one month for buys and six

months for sells.

Our paper differs from those of Stickel and Womack in two important respects. First, we

analyze more than twenty times as many recommendations and a much longer period of time than

do either Stickel or Womack. Second, we study analyst recommendations, themselves, rather

than changes in their ratings. This shifts the analysis away from the immediate price reaction to

analyst upgrades and downgrades and allows us to focus on the calendar-time returns earned from

following strategies based on the consensus recommendations of covered firms. By doing so, we

take the perspective of the investor rather than the individual analyst.

The difference in these perspectives can be illustrated by considering the example of

Compaq Computer, which received 11 upgrades or downgrades on March 1, 1996. In our

4
analysis, this firm would be represented once on that day; in Stickel's and Womack's analyses,

each of the upgrades and downgrades would represent an observation.6 Implicit in our analysis,

then, is the assumption that an investor does not choose weights for each stock in his or her

portfolio according to the number of strong buy recommendations the firm has received, but,

rather, according to its consensus recommendation. Although an individual investor could, of

course, follow such a strategy, in aggregate a stock must be held in proportion to its market

capitalization, not in proportion to the number of strong buy recommendations it receives.

The plan of this paper is as follows. In Section I we describe the data and our sample

selection criteria. A discussion of our research design follows in Section II. In Section III we

form portfolios according to consensus analyst recommendations and analyze their returns.

Additional tests are performed in Section IV. In Section V we estimate the transactions costs of

following the strategy of buying the most highly rated stocks and selling short those that are least

favorably rated and discuss the profitability of this strategy. A summary and conclusions section

ends the paper.

I. THE DATA, SAMPLE SELECTION CRITERIA, AND DESCRIPTIVE STATISTICS

The analyst recommendations used in this study were provided by Zacks Investment

Research, who obtains its data from the written and electronic reports of brokerage houses. The

recommendations encompass the period 1985 (the year that Zacks began collecting this data)

6
The clustering of upgrades or downgrades in time can also lead to event-centered returns that are cross-
sectionally dependent. Indeed, if the same firm receives multiple upgrades on the same day, the event-centered returns
for these upgrades will be perfectly correlated. This cross-sectional dependence renders traditional statistical tests in
event studies invalid. See Brav (1998), Fama (1998), and Lyon, Barber, and Tsai (1998) for further discussion of this
issue.

5
through 1996. Each database record includes, among other items, the recommendation date,

identifiers for the brokerage house issuing the recommendation and the analyst writing the report

(if the analysts identity is known), and a rating between 1 and 5. A rating of 1 reflects a strong

buy recommendation, 2 a buy, 3 a hold, 4 a sell, and 5 a strong sell. This five-point scale is

commonly used by analysts. If an analyst uses a different scale, Zacks converts the analysts

rating to its five-point scale.

Ratings of 6 also appear in the Zacks database and signify termination of coverage. This

rating will be given when an analyst announces that he or she is dropping coverage of a firm,

when the analyst switches brokerage houses, or when the analyst is restricted from covering the

firm for a period of time, possibly due to the initiation of investment banking activity between the

analysts brokerage house and the firm. A rating of 6 may also be assigned by Zacks if the analyst

has not issued a new recommendation within the last 366 days. By doing so, Zacks is making the

implicit assumption that the analyst is no longer following the firm, but that the analyst has not

made a formal announcement to this effect.

In some instances the date assigned to a recommendation by Zacks will be later than the

date on which the recommendation becomes publicly available. This situation will arise, for

example, if Zacks uses the date of publication of an analysts written report but the analyst

publicly announced his recommendation a few days earlier. In this case, investors will have been

able to act on the recommendation before the date recorded by Zacks. To the extent that this is a

prevalent occurrence, our tests for investment value in analysts recommendations will be less

powerful.

Another characteristic of the database, one that has not been explicitly acknowledged in

6
any prior study as far as we are aware, is that the data made available to academics does not

constitute Zacks complete set of recommendations. According to an official at Zacks, some

individual brokerage houses have entered into agreements that preclude their recommendations

from being distributed by Zacks to anyone other than the brokerage houses clients.

Consequently, the recommendations of several brokerage houses, including such large ones as

Merrill Lynch, Goldman Sachs, and Donaldson, Lufkin, and Jenrette, are not part of the database

that has been analyzed by academics.7

The Zacks database contains 378,326 recommendations for the years 1985-1996.

Dropping observations for the 1,286 firms not appearing on the CRSP file leaves a final sample of

361,620 recommendations. Table I provides descriptive statistics for these recommendations. As

shown in column 3, the number of firms covered by Zacks has increased steadily over the years.

For the year 1996, 59.8 percent of all firms on the NYSE, ASE, or NASDAQ had at least one

recommendation in the database (column 4). The market capitalization of these firms constituted

95.6 percent of the capitalization of all firms in the market (column 5). This is consistent with the

conventional wisdom that analysts tend to cover larger firms, because they offer more liquidity

and allow the analysts clients to more easily take large positions in the firms shares.

The mean number of analysts per covered firm has increased over time, in general (column

6), while the median number has remained constant, with the exception of 1985 (column 7).

From 1986 onward, the mean and median number of covered firms per analyst has also been

stable (columns 8 and 9). The number of brokerage houses contributing recommendations to

7
Given the high ratings that many analysts at these brokerage firms receive in surveys of institutional investors,
this omission most likely biases our tests against finding investment value in analysts recommendations.

7
Zacks and the number of analysts providing forecasts has steadily increased over time (columns

10 and 11). The last column of the table reports the average of all of the analyst ratings, by year.

It shows a rather steady decrease over time, indicating that analysts recommendations have

become more favorable.

Finally, it should be noted that the year 1985 has by far the smallest number of covered

firms, brokerage houses, and analysts. Because 1985 is the first year that Zacks began tracking

recommendations, this finding is not at all surprising. Since the 1985 data is so sparse, though,

we do not include the investment returns from that year in our analysis.8 However, we do use the

recommendations, themselves, as they are needed to calculate consensus ratings for 1986 (to the

extent that the recommendations carry over to that year).

A 6 x 6 transition matrix of the analysts recommendations appears in table II. Each cell

{i,j} of the matrix contains two numbers. The top one is the number of observations in the

database in which an analyst moved from a recommendation of i to one of j; the bottom number is

the median number of days between the announcement of a recommendation of i and a revised

recommendation of j. The diagonal elements of the matrix reflect reiterations of analyst

recommendations. Most of the entries in this matrix are concentrated in the upper 3 x 3 cells.

This is to be expected, given the conventional wisdom that analysts are reluctant to issue sell

recommendations. Within this region, the bulk of the observations represent reiterations. The

mean time between a recommendation and its reiteration is a little less than 300 days. This is

much longer than the mean time between a recommendation and a revision by the analyst to a new

rating, which is generally in the low 100-day range.

8
Our inferences are not affected by the exclusion of the 1985 returns.

8
 The line entitled First Zacks Recommendation records the first recommendation in the

database for a given analyst-company pair. Consistent with McNichols and OBrien (1998), the

first recommendation is usually a buy (1 or 2), less often a hold, and rarely a sell (4 or 5). This

again reflects the reluctance of analysts to issue sell recommendations. This observation is also

consistent with the numbers in the last two lines of the table. Of all the recommendations in the

database 47.1 percent are buys while only 5.7 percent are sells. Excluding observations with a

rating of 6, buys constitute 54.1 percent of the total, while sells make up only 6.3 percent.

As a general check on the accuracy of our data, we computed the average two-day

announcement period return for changes in or initiations of analyst recommendations. These

returns are presented in table III. Similar to the results of Stickel (1995) and Womack (1996) we

find that the compound return (adjusted for size) for the day before and day of the announcement

of a rating change is, in general, significantly positive for upgrades and significantly negative for

downgrades. Furthermore, for the set of initial analyst-company recommendations in the

database, a buy rating (1 or 2) is accompanied by a significantly positive return, while a hold or

sell rating (3, 4, or 5) is associated with a significantly negative return. These significant findings

provide supporting evidence for the accuracy of the recommendations and the recorded

announcement dates in the Zacks database.

II. RESEARCH DESIGN

A. Portfolio Construction

To determine whether analysts recommendations are predictive of future returns we

construct calendar-time portfolios based on the consensus rating of each covered firm. The

9
average analyst rating, AG iJ-1, for firm i on date J-1 is found by summing the individual ratings,

AijJ-1, of the j = 1 to niJ-1 analysts who have outstanding recommendations for the firm on that day

and dividing by niJ-1. Formally,

niJ&1

j AijJ&1.
1
AiJ&1 '
niJ&1 j'1

Using these average ratings, each of the covered firms is placed into one of five portfolios as of

the close of trading on date J-1. The first portfolio consists of the most highly recommended

stocks, those for which 1#AG iJ-1#1.5; the second is comprised of firms for which 1.5<AG iJ-1#2; the

third contains firms for which 2<AG iJ-1#2.5; the fourth is comprised of firms for which 2.5<AG iJ-1#3;

and the fifth portfolio consists of the least favorably recommended stocks, those for which AG iJ-1>3.

The number of portfolios chosen and the ratings cutoffs for each, while somewhat

arbitrary, are certainly reasonable. Five portfolios were chosen so as to achieve a high degree of

separation across firms in the sample while retaining sufficient power for our tests. The cutoffs

were set so that only the bottom portfolio contained firms whose consensus ratings corresponded

to hold or sell recommendations, due to the relative infrequency of such ratings. We also ran our

main analysis under the alternative specification that the top portfolio contain only firms with an

average rating of one, and obtained generally similar results.9

After determining the composition of each portfolio p as of the close of trading on date

J-1, the value-weighted return for date J was calculated. Denoted by RpJ for portfolio p, this

9
Such a cutoff results in the top portfolio being comprised of firms with small analyst followings. This is
because a rating of one is only possible if all the analysts covering a firm give it a strong buy recommendation. The
more analysts there are, the less likely a firm will be able to obtain this rating.

10
return is given by:

npJ&1
RpJ ' j xiJ&1RiJ,
i'1

where:

xiJ-1 = the market value of equity for firm i as of the close of trading on date J-1 divided by the

aggregate market capitalization of all firms in portfolio p as of the close of trading on that date,

RiJ = the return on the common stock of firm i during date J, and

npJ-1 = the number of firms in portfolio p at the close of trading on date J-1.

There are two reasons we value-weight rather than equally-weight the securities in each portfolio.

First, an equal weighting of daily returns (and the implicit assumption of daily rebalancing) leads

to portfolio returns that are severely overstated.10 Second, while an individual investor could hold

equal amounts of each security, in the aggregate each firm must be held in proportion to its

market value.

For each month in our sample period, the daily returns for each portfolio p, RpJ, are

compounded over the n trading days of the month to yield a monthly return, Rpt:

Rpt ' k (1%RpJ) & 1.

n

J'1

10
This problem arises due to the cycling over time of a firms closing price between its bid and ask (commonly
referred to as the bid-ask bounce). For a more detailed discussion see Barber and Lyon (1997), Canina, Michaely,
Thaler, and Womack (1998), and Lyon, Barber, and Tsai (1998).

11
Our study focuses on the monthly returns for the five constructed portfolios, as well as for two

additional portfolios. The first additional portfolio consists of all covered firms on each date J

(those that received a rating from at least one analyst in the Zacks database on that day) and the

second portfolio consists of neglected firms on that date (those firms on the CRSP daily returns

file that did not receive any analyst ratings that day).11 The composition of each of these two

portfolios is recalculated every day, since firms gain or lose analyst coverage over time.

B. Performance Evaluation

Our analysis of portfolio performance begins with a simple calculation of market-adjusted

returns. It is given by Rpt - Rmt for portfolio p in month t, where Rmt is the month t return on the

CRSP value-weighted market index. We next calculate three measures of abnormal performance

for each of our constructed portfolios. First, we employ the theoretical framework of the Capital

Asset Pricing Model and estimate the following monthly time-series regression:

Rpt ! Rft ' "p % $p(Rmt ! Rft) % ,pt,

where:

Rft = the month t return on treasury bills having one month until maturity,12

"p = the estimated CAPM intercept (Jensen's alpha),

$p = the estimated market beta, and

11
Since the academic version of the Zacks database does not include the recommendations of all brokerage
houses, it is possible that some of the neglected firms are actually covered by one or more analysts. To the extent this
is true, our test for differences in returns between neglected and covered firms is less powerful.
12
This return is taken from Stocks, Bonds, Bills, and Inflation, 1997 Yearbook, Ibbotson Associates, Chicago,
IL.

12
,pt = the regression error term.

This test yields parameter estimates of "p and $p.

Second, we employ an intercept test using the three-factor model developed by Fama and

French (1993). To evaluate the performance of each portfolio, we estimate the following monthly

time-series regression:

Rpt ! Rft ' "p % $p(Rmt ! Rft) % spSMB t % hpHMLt % ,pt,

where:

SMBt = the difference between the month t returns of a value-weighted portfolio of small stocks

and one of large stocks, and

HMLt = the difference between the month t returns of a value-weighted portfolio of high book-to-

market stocks and one of low book-to-market stocks.13

The regression yields parameter estimates of "p, $p, sp, and hp.

A third test includes a zero investment portfolio related to price momentum, as follows:

Rpt ! Rft ' "p % $p(Rmt ! Rft) % spSMBt % h pHMLt % mpPMOMt % ,pt.

PMOMt is the equally-weighted month t average return of the firms with the highest 30 percent

return over the eleven months through month t-2, less the equally-weighted month t average

13
The construction of these portfolios is discussed in detail in Fama and French (1993). We thank Ken French
for providing us with this data.

13
return of the firms with the lowest 30 percent return over the eleven months through month t-2.14

In addition to estimates of "p, $p, sp, and hp, this regression yields a parameter estimate of mp.

This specification will be referred to below as the four-characteristic model.

In the analysis below we use the estimates of $p, sp, hp, and mp to provide insights into the

nature of the firms in each of the portfolios. A value of $p greater (less) than one indicates that

the firms in portfolio p are, on average, riskier (less risky) than the market. A value of sp greater

(less) than zero signifies a portfolio tilted toward smaller (larger) firms. A value of hp greater

(less) than zero indicates a tilt toward stocks with a high (low) book-to-market ratio. Finally, a

value of mp greater than zero signifies a portfolio with stocks that have, on average, performed

well (poorly) in the recent past.

It is important to note that our use of the Fama-French and four-characteristic models

does not imply a belief that the small firm, book-to-market, and price momentum effects represent

risk factors. Rather, we use these models to assess whether any superior returns that are

documented are due to analysts stock-picking ability or to their choosing stocks with

characteristics known to produce positive returns.

C. Turnover

Both the raw and risk-adjusted returns reported in the tables are gross of any trading costs

arising from the bid-ask spread, brokerage commissions, and the market impact of trading. To

assess the size of these costs we calculate a measure of daily turnover for each portfolio.

14
The rationale for using price momentum as a factor stems from the work of Jegadeesh and Titman (1993)
who show that the strategy of buying stocks that have performed well in the recent past and selling those that have
performed poorly generates significant positive returns over three to twelve month holding periods. This measure of
price momentum has been used by Carhart (1997). We thank Mark Carhart for providing us with the price momentum
data.

14
Turnover for portfolio p during trading day J is defined as the percentage of the portfolios

holdings as of the close of trading on date J-1 that has been sold off as of the close of trading on

date J. That is, it is the percent of the portfolio that has been turned over into some other set of

stocks during date J.

Turnover is calculated by following a three-step procedure. First, for each stock i in

portfolio p as of the close of trading on date J-1 we calculate the fraction it would have

comprised of the portfolio at the end of trading on date J if there were no portfolio rebalancing.

Denoting this fraction by GiJ, it is given by

xiJ&1(1%RiJ)
GiJ ' ,
npJ&1

j xiJ&1(1%RiJ)
i'1

where, as before, xiJ-1 is the market value of equity for firm i as of the close of trading on date J-1

divided by the aggregate market capitalization of all firms in portfolio p as of the close of trading

on that date. Next, GiJ is compared to the actual fraction firm i makes up of portfolio p at the end

of trading on date J, denoted by FiJ, taking into account any portfolio rebalancing required as a

result of changes in analyst recommendations. Finally, the decrease (if any) in the percentage

holding of each of the date J-1 securities is summed, yielding the days portfolio turnover.

Denoted by UiJ, it is formally given by:

npJ
UiJ ' j max{GiJ&FiJ,0}.
i'1

15
Annual turnover is then calculated by multiplying UiJ by the number of trading days in the year.

III. PORTFOLIO CHARACTERISTICS AND RETURNS

Table IV provides descriptive statistics for portfolios formed on the basis of analysts

recommendations. Note first that the average number of firms in the portfolio of the least

favorably ranked stocks, portfolio 5, is less than one-third that of any of the other four portfolios

(column 2). This is not surprising, given the reluctance of analysts to issue sell recommendations.

The average numbers of firms in the other four portfolios are roughly similar. There is

considerable variation across portfolios in the average number of analysts per firm, though,

ranging from a low of 2.35 for portfolio 1 to a high of 4.93 for portfolio 3 (column 3). The low

number of analysts for firms in portfolio 1 may well reflect the difficulty a firm has in attaining an

average rating of between 1 and 1.5 if there are many analysts covering it, and leads one to

suspect that these firms are relatively small. This is confirmed by the data in column 5, which

shows the market capitalization of these firms to be considerably smaller than that of the firms in

portfolios 2, 3, and 4. The market capitalization of the firms in portfolio 5 is also small. This is

consistent with the conventional wisdom that analysts are reluctant to issue sell recommendations

for firms that might generate future investment banking business, which presumably are the larger

firms.

The annual turnover of each portfolio is given in column 6. It is remarkably stable across

the five portfolios, varying from a low of 425 percent for portfolio 2 to a high of 476 percent for

portfolio 5. These numbers are relatively high, especially when compared to an annual turnover

figure of 12 percent for the portfolio of all covered firms, 70 percent for the neglected firm

16
portfolio, and only 7 percent for a portfolio comprised of all the firms on CRSP. These high

turnover numbers are driven by the fact that, conditional on receiving coverage, a firm changes

portfolios 3.81 times per year, on average.

Table IV also presents the estimated coefficients for the four-characteristic model. The

significant coefficients on market risk premium, SMB, and HML (columns 7-9) for portfolio 1 are

indicative of small growth stocks with higher than average market risk. The significant

coefficients on SMB, HML and PMOM (column 10) for portfolio 5 reflect small value firms that

have performed poorly in the past. The coefficient on the market risk premium generally

decreases as we move from portfolio 1 to portfolio 5 whereas the coefficient on HML increases,

indicating that less favorable analyst ratings are associated with firms of lower market risk and

higher book-to-market ratios. Compared to covered firms as a whole, neglected stocks are, on

average, less risky, smaller, and tilted toward value.

Table V presents our main results, which strongly support the hypothesis that analysts

recommendations have investment value. There is a monotonic decrease in raw returns (column

2) and market-adjusted returns (column 3) as we move from more highly to less highly

recommended stocks. The cumulative market-adjusted returns for the five portfolios are plotted

in calendar time in figure 1. The central message of our investigation is clear from this figure:

more highly recommended stocks consistently outperform less highly recommended ones. Over

the entire 11 year period, portfolio 1's cumulative market-adjusted return is close to 50 percent,

while portfolio 5's cumulative return is nearly -90 percent, a 140 percentage point spread.

One might conjecture that the patterns in market-adjusted returns can be explained by the

market risk, size, book-to-market, and price momentum characteristics of the recommended

17
stocks. The intercept tests from the CAPM, the Fama-French three-factor model, and the four-

characteristic model provide strong evidence that they cannot. In every case, the intercept tests

(presented in columns 4, 5, and 6 and illustrated in figure 2) indicate that more highly rated stocks

have higher abnormal returns than less highly rated stocks. Furthermore, the abnormal returns for

portfolios 1 and 2 are each significantly positive in all three models while the abnormal returns for

portfolio 5 are significantly negative.

A comparison of the abnormal returns on portfolios 1 and 5 shows the return that can be

generated from a strategy of purchasing the highest ranked securities and selling short the lowest

ranked ones. It ranges from a low of 0.753 percent per month under the four-characteristic model

to a high of 0.989 percent per month using the Fama-French three-factor model. Purchasing the

second most highly rated stocks, those in portfolio 2, and selling short the second least favorably

rated stocks, those in portfolio 4, also produces significant, although smaller, returns. They range

from 0.236 percent per month under the CAPM to 0.354 percent using the Fama-French three-

factor model.

Table V also reveals that a portfolio of all covered stocks earns positive and significant

abnormal returns, while the abnormal returns of neglected stocks are negative and significant.

The return to be earned from purchasing the covered firms and selling short the neglected stocks

ranges from a low of 0.298 percent per month using the four-characteristic model to a high of

0.330 percent under the CAPM. The underperformance of neglected stocks is consistent with

evidence in McNichols and OBrien (1998) that analysts tend to drop coverage of firms that they

expect to do poorly, rather than retain them and issue negative comments. In contrast to our

empirical findings, Arbel, Carvel and Strebel (1983) document that during the 1970's neglected

18
firms actually earned superior returns. There are a few possible explanations for these seemingly

contradictory results. First, Arbel et. al. restricted their attention to large firms (the S&P 500),

whereas our neglected firms are relatively small. Second, some of their neglected firms actually

had an analyst following them. Third, they did not control for possible book-to-market effects.

(As we show, neglected firms have higher book-to-market ratios.) During their sample period of

1970-1979, high book-to-market firms outperformed low book-to-market firms by 57 basis points

per month.

IV. ADDITIONAL ANALYSES

In this section we partition the analysts recommendations, first according to firm size,

then by subperiod, and then by overall market direction. As will be apparent, the performance

results within each partition generally match those for the sample as a whole. We also consider

whether positive abnormal performance can still be achieved if investors delay acting on changes

in consensus analyst recommendations for a short time.

A. Firm Size

There are several reasons to analyze investment returns on the basis of firm size. First, to

the extent that there is less information publicly available about smaller firms, we would expect

the investment performance of analysts recommendations to be greater for them. Further,

consistent with Shleifer and Vishny (1997) and Pontiff (1996), it is likely that investors ability to

arbitrage away any excess returns will be smallest for these firms.15 In addition, it is important to

15
Shleifer and Vishny (1997) argue that arbitrage has only a limited ability to align prices with fundamental
values and that this limitation is greatest among securities with high volatility (such as small stocks). Pontiff (1996)
adds that arbitrage will be limited when transaction costs are relatively high (as is again the case for small stocks).

19
understand the extent to which analysts recommendations can generate excess returns for larger

firms as well, as they represent a greater share of the investment opportunities available in the

market.

In short, we find the results of our analysis to be most pronounced for small and medium-

sized firms. Among the few hundred largest firms, we find no significant difference between the

returns of the most highly rated stocks and those that are least favorably recommended. If return

differences are attributable to a market inefficiency (a notion we discuss in greater detail in

Section VI), the mispricing occurs precisely where it would be expected -- among small and

medium-sized firms, where information is least available, the costs of trading are high, and

arbitrage is most risky.

Table VI presents the returns for our size partition. Following the criteria used by Fama

and French (1993), size deciles are formed on the basis of NYSE firm-size cutoffs and are

adjusted annually, in December. Each ASE and Nasdaq firm is placed in the appropriate NYSE

size decile based on the market value of its equity as of the end of December. Big firms (B) are

defined as those in the top three deciles, small firms (S) are those in the bottom three deciles, and

medium firms (M) are those in the middle four. Of all covered stocks, the number of small firms

in our sample averages 1,957 per month, the number of medium firms averages 827, and the

number of big firms averages 339. Though there are relatively few large firms (about 10 percent

of all covered firms and only 5 percent of all firms), they represent approximately 70 percent of

the total market capitalization of all firms listed on the NYSE, ASE, and Nasdaq. Medium and

small firms represent 20 and 10 percent of total market capitalization, respectively.

For all return models, the most highly recommended stocks earn positive abnormal

20
returns, while the least favorably recommended ones earn negative abnormal returns. The

difference between the returns of the most highly and least favorably recommended stocks is

significantly positive for small and medium-sized firms; it is statistically insignificant for large

firms in two of the three return models. In all cases, the portfolio of all covered firms earns

greater abnormal returns than does the neglected firm portfolio. The difference is significant for

the small firms, regardless of the return model employed. It is significant for medium-sized firms

in two of the three models, but is statistically insignificant for the large firms in all cases.

B. Subperiod Analysis

To investigate whether our results are driven by a few years in which highly recommended

stocks outperformed less favorably recommended ones, we now turn to a subperiod analysis of

our sample. Figure 3 plots the monthly raw returns for the five portfolios, cumulated by year.

The abnormal return from purchasing portfolio 1 and selling short portfolio 5 ranges from a low

of approximately 2 percent to a high of 25 percent, and is greater than 10 percent in seven of the

eleven years. The yearly abnormal return from purchasing portfolio 2 and selling short portfolio

4, while smaller, remains positive in eight of the eleven years. Purchasing the covered firms and

selling short the neglected stocks generates a positive abnormal return in nine of the eleven years.

This provides confirming evidence that our results are robust across time.

Additional confirmation comes from a partition of our sample into two time periods, the

first covering 1986-1990 and the second covering 1991-1996 (table VII). We estimate separate

regressions for each set of years and allow the coefficients of each of the factors to differ over the

two periods. The estimated intercepts are not significantly different across periods. Fewer of

21
them are significant, though, likely due to a reduction in the power of our tests. (We have only 60

observations for the first subperiod and 72 for the second subperiod.) The abnormal return for

the least favorably recommended stocks does remain significantly negative, and the abnormal

return on portfolio 1 is again significantly greater than that of portfolio 5. Additionally, the

covered firms earn a significantly higher return than the neglected firms in both time periods using

the Fama-French three-factor model and in one subperiod for each of the other two models.

C. Bull Market and Bear Market Returns

As a bull market predominated during most of our sample period of 1986-1996, a question

naturally arises as to whether the superior investment performance of highly recommended stocks

has been driven primarily by the strong market. To address this question, we partition our sample

period into bull and bear market months, where a bull (bear) month is defined as one in which the

CRSP value-weighted market index return is positive (negative).16 Using this definition, 68

percent of the sample months were categorized as bull markets and 32 percent as bear markets.

We estimate separate intercepts for bull and bear months, but assume the coefficients on the

factors are the same. This reflects the notion that while analysts may be better at picking stocks in

up markets than in down markets, a firms association with the various factors should remain the

same, particularly given that bull and bear market months are scattered throughout the sample

period.

These regressions yield intercepts for the covered stock portfolios that are not significantly

different across bull and bear markets (table VIII). As in the subperiod partition, fewer of the

16
Our analysis is similar in spirit to that of Lakonishok, Shleifer, and Vishny (1994) who analyze the returns of
value and glamour stocks in both strong and weak markets.

22
abnormal returns are significant. With the exception of the market-adjusted returns, which do not

take into account the greater market risk of highly recommended stocks, the abnormal return on

portfolio 1 remains significantly higher than that on portfolio 5 and is greater in bear than in bull

markets. Interestingly, covered firms, on average, appear to do worse than neglected firms in

bear markets and better in bull markets.

D. Delaying Investors Reaction to Changes in Consensus Analyst Recommendations

The analysis thus far has assumed that investors act on a given consensus analyst

recommendation at the close of trading on the day the consensus recommendation changes. An

interesting question is whether it is crucial for investors to move so quickly. To address this

question we calculate the returns that investors would have earned if they waited a short time

before acting on changes in consensus recommendations.

Table IX documents the investment performance that can be achieved on portfolios 1

through 5, assuming waiting periods of one calendar day (Panel A), 15 calendar days (Panel B),

and 30 calendar days (Panel C). For a one-day waiting period the abnormal return for portfolio 1

remains significantly positive in two of the three models, but becomes insignificant when the

waiting period is extended to 30 days. In contrast, the abnormal return for portfolio 5 remains

significant in all cases.17 (These results are illustrated in figure 4.) The abnormal return from a

strategy of purchasing portfolio 1 and selling short portfolio 5 remains significantly greater than

zero for waiting periods of one and 15 days; it is positive in two of the three models for a 30-day

waiting period. While the magnitude of these returns decreases with the waiting period, these

17
Stickel (1995) and Womack (1996) also find the post-recommendation stock drifts in their samples to be
stronger for the least favorably recommended stocks.

23
results suggest that investors need not immediately act on analysts recommendations in order to

earn a positive abnormal return.

V. TRANSACTIONS COSTS

All returns presented thus far have been gross of the transactions costs associated with the

bid-ask spread, brokerage commissions, and the market impact of trading. Brokerage

commissions are relatively small, at least for institutions, while the market impact of trading is

difficult to measure. The round-trip cost of the bid-ask spread has been estimated to be 1 percent

for mutual funds (Carhart (1997)) as well as for individual investors (Barber and Odean (1998)).

In conjunction with the calculated turnover for each portfolio (see column 6 of table IV), this

percentage can be used to assess the impact of the bid-ask spread on investment returns. (The

method for computing turnover was described in Section II.C.)

A bid-ask spread of 1 percent implies, for each portfolio, a total transactions cost that is at

least equal to 1 percent of its annual turnover. Referring again to column 6 of table IV, the

minimum annual cost associated with portfolio 1 is then 4.56 percent. This compares to an

annualized abnormal gross return of 4.2 percent, using the Fama-French three-factor model. This

means that an active strategy of buying the most highly recommended stocks yields an abnormal

net return that is not reliably different from zero. The annual transactions cost associated with a

strategy of purchasing the stocks in portfolio 1 and selling short those in portfolio 5 is 9.32

percent (the sum of 4.56 percent for portfolio 1 and 4.76 percent for portfolio 5). This compares

to an annualized abnormal gross return of 11.9 percent, again using the Fama-French three-factor

model. While the net return is positive in this case, the funds invested could have alternatively

24
been used to buy risk-free securities, yielding much more than the approximately 2.6 percent net

return that this strategy provides.18 A strategy of purchasing a portfolio of all of the covered firms

and selling short the neglected stocks costs 0.82 percent annually (the sum of 0.12 percent for the

covered stocks and 0.70 percent for the neglected firms). This compares to a 3.9 percent

abnormal gross return, using the Fama-French model. Again, while the net return is positive, it is

less than could have been earned in a risk-free security.

These results notwithstanding, the consensus recommendations remain valuable to

investors who are otherwise considering buying or selling. All else the same, an investor would

be better off purchasing shares in firms with more favorable consensus recommendations and

selling shares in those with less favorable consensus recommendations.

VI. SUMMARY AND CONCLUSIONS

In this paper, we document that a strategy of purchasing stocks that are most highly

recommended by security analysts and selling short those that are least favorably recommended

yields a return of 102 basis points per month over the 1986-1996 period. The magnitude of this

return is very large, and is far greater than the size (negative 16 basis points) and book-to-market

(17 basis points) effects for the same period. Even after controlling for these effects, as well as

price momentum, we document that this strategy yields a return of 75 basis points per month.

18
A strategy of investing in a single portfolio must only earn an abnormal return greater than zero to be
profitable, as the abnormal return is already net of the risk-free rate. In contrast, a strategy of investing in one portfolio
and selling short another must earn an abnormal return greater than the risk-free rate to be profitable. This is because
the portfolio that is sold short adds back this rate to the abnormal return. Consequently, the difference between the
abnormal returns of the portfolio purchased and the one sold short is no longer net of the risk-free rate. Of course, if the
proceeds from the short sale were freely available to the investor to invest in a risk-free security (which they are not, in
general), the benchmark return for the zero-investment strategy would be zero as well.

25
Our results are robust to partitions by time period and overall market direction.

We were surprised by the strength and robustness of our findings, especially since there is

no extant theory of asset pricing that can explain them. This leaves three potential explanations

for our findings: (1) random chance (that is, data-snooping), (2) a poor model of asset pricing, or

(3) market inefficiency.

Many financial economists (for example Fama (1998)) view documented patterns in stock

returns with great skepticism and argue that the documented anomalies are simply a result of

extensive data-snooping by academics. Even the relation between stock returns and either firm

size or book-to-market ratio lacks strong theoretical foundations and, as such, has been attributed

by some to data-mining (see, for example, Black (1993) and MacKinlay (1995)).

We are sensitive to this interpretation of our results. However, it is unlikely that they are

due to random chance, for three reasons. First, Wall Street firms spend billions of dollars annually

on security analysis; it is difficult to understand why they do so if analysts recommendations do

not have investment value. Second, if our results were driven by mere chance, they would be an

exceedingly rare outcome, occurring in less than 1 of 1,600 randomly generated portfolios.19

Third, our results are robust to several different partitions of the data.

Every test of a null hypothesis that long-run abnormal stock returns are zero is implicitly a

joint test of the hypotheses that (1) these returns are zero and (2) the asset pricing model used to

estimate abnormal returns is valid. Assume that the results we document are not driven by

chance, but, rather, are attributable to a poor model of asset pricing. This implies that highly

19
This is based on the t-statistic of 3.495 for the difference between the intercepts for portfolios 1 and 5 using
the CAPM.

26
recommended stocks, which earn higher average returns, are riskier than less favorably

recommended stocks, which earn lower average returns. Apart from the fact that most investors

would consider less favorably recommended stocks to be riskier investments than highly

recommended stocks (ceteris paribus), we find no obvious source of increased risk from holding a

well-diversified portfolio of highly recommended stocks. Furthermore, if increased risk really

could explain the higher average returns earned by highly recommended stocks, this risk must be

fleeting, since much of the higher average returns disappear a few weeks after the change in

consensus analyst recommendation. Thus, it does not appear that our results can reasonably be

attributed to a poor model of asset pricing.

We believe our results most likely represent a market inefficiency, and one that is unlikely

to be eliminated by arbitrage. Such arbitrage would involve investing in a hedge portfolio that is

long the most highly recommended securities and short the least favorably recommended ones.

Yet, we document that a reasonable accounting for transaction costs renders this arbitrage

strategy, which requires intensive trading, unprofitable. Furthermore, this hedge is far from

perfect; in 39 percent of the months, the poorly recommended stocks outperform the highly

recommended ones. Thus, an arbitrageur also faces the risk that the mispricing will worsen in the

short term.

Consistent with the notion of market inefficiency, we find the difference between the

returns of the most highly rated and least favorably recommended stocks to be most pronounced

for small and medium-sized firms, where there is less publicly-available information and where the

costs of trading are highest and arbitrage most risky. In contrast, among the few hundred largest

firms, which represent 70 percent of the market capitalization of all firms listed on the NYSE,

27
ASE, and Nasdaq, we find no reliable differences between the returns of those most highly and

least favorably recommended stocks. For these firms, the market appears to be efficient with

respect to analysts recommendations.20

Thousands of analysts scour the landscape for securities that are mispriced. Each day,

analysts issue hundreds of new recommendations. In an efficient market, prices would

immediately and fully respond to these new recommendations. Indeed, markets do respond to

them; but, the response appears to be incomplete. The bulk of the empirical evidence supports a

simple, but controversial conclusion: security analysts do identify mispriced stocks, but financial

markets do not completely appreciate their ability to do so.

20
Neither of the competing explanations for our results (data mining or a poor model of asset pricing) would
lead us to expect stronger results among small and medium-sized firms.

28
 REFERENCES

Arbel, A., S. Carvel, and P. Strebel, 1983, Giraffes, Institutions and Neglected Firms, Financial
Analysts Journal, 39, 57-63.

Arbel, A. and P. Strebel, 1983, Pay Attention to Neglected Firms!, 9, 37-42.

Barber, B. and D. Loeffler, 1993, The Dartboard Column: Second-hand Information and Price
Pressure, Journal of Financial and Quantitative Analysis, 28, 273-284.

Barber, B. and Lyon, J., 1997, Detecting Long-run Abnormal Stock Returns: The Empirical
Power and Specification of Test Statistics, Journal of Financial Economics, 43, 341-
372.

Barber, B. and T. Odean, 1998, The Common Stock Investment Performance of Individual
Investors, working paper, University of California, Davis.

Bidwell, C., 1977, How Good is Institutional Brokerage Research?, Journal of Portfolio
Management, 3, 26-31.

Black, F., 1993, Beta and Return, Journal of Portfolio Management, 20, 8-18.

Brav, A., 1998, Inference in Long-horizon Event Studies: A Bayesian Approach with
Application to Initial Public Offerings, working paper, University of Chicago.

Canina, L., R. Michaely, R. Thaler, and K. Womack, 1998, Caveat Compounder: A Warning
about Using the Daily CRSP Equal-Weighted Index to Compute Long-Run Excess
Returns, Journal of Finance, 53, 403-416.

Carhart, M., 1997, On Persistence in Mutual Fund Performance, Journal of Finance, 52, 57-82.

Copeland, T. and D. Mayers, 1982, The Value Line Enigma (1965-1978): A Case Study of
Performance Evaluation Issues, Journal of Financial Economics, 10, 289-322.

Desai, H. and P. Jain, 1995, An Analysis of the Recommendations of the Superstar Money
Managers at Barrons Annual Roundtable, Journal of Finance, 50, 1257-1273.

Diefenbach, R., 1972, How Good is Institutional Brokerage Research?, Financial Analysts
Journal, 28, 54-60.

Fama, E., forthcoming, Market Efficiency, Long-term Returns and Behavioral Finance, Journal
of Financial Economics.

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Fama, E. and K. French, 1993, Common Risk Factors in the Return on Bonds and Stocks,
Journal of Financial Economics, 33, 3-53.

Groth, J, W. Lewellen, G. Schlarbaum, and R. Lease, 1979, An Analysis of Brokerage House

Securities Recommendations, Financial Analysts Journal, 35, 32-40.

Jegadeesh, N. and S. Titman, 1993, Returns to Buying Winners and Selling Losers: Implications
for Stock Market Efficiency, Journal of Finance, 48, 65-91.

Lakonishok, J., A. Shleifer, and R. Vishny, 1994, Contrarian Investment, Extrapolation, and
Risk, Journal of Finance, 49, 1541-1578.

Lyon, J., B. Barber, and C. Tsai, forthcoming, Improved Methods for Tests of Long-run
Abnormal Stock Returns, Journal of Finance.

MacKinlay, A., 1995, Distinguishing Among Asset Pricing Theories: An Ex-Ante Analysis,
Journal of Financial Economics, 38, 3-28.

McNichols, M. and P. OBrien, 1998, Self-Selection and Analyst Coverage, Journal of

Accounting Research, 35, 167-199.

Pontiff, Jeffrey, 1996, Costly Arbitrage: Evidence from Closed-End Funds, Quarterly Journal
of Economics, 111, 1135-1152.

Schleifer, R. and A. Vishny, 1997, The Limits of Arbitrage, Journal of Finance, 52, 35-55.

Stickel, S., 1995, The Anatomy of the Performance of Buy and Sell Recommendations,
Financial Analysts Journal, 51, 25-39.

Womack, K, 1996, Do Brokerage Analysts Recommendations Have Investment Value?,

Journal of Finance, 51, 137-167.

30
 Table I
Descriptive Statistics on Analyst Recommendations from the Zacks Database, 1985-1996

The number of listed firms includes all firms listed on the CRSP stock return file, by year. The number of covered firms is the number of firms with at least one valid
recommendation in the Zacks database, by year. The number of covered firms is also expressed as the % of the number of listed firms. The market capitalization of covered
firms as a percent of the total market capitalization is the average daily ratio between the sum of the market capitalizations of all covered firms and the market value of all
securities used in the CRSP daily value-weighted indices. The mean and median number of analysts issuing recommendations for each covered firm is shown, as is the mean
and median number of firms covered by each analyst in the database, by year.This is followed by the number of brokerage houses and number of analysts with at least one
recommendation during the year. The last column is the average of all analyst recommendations in the database for the year .

Covered Firms Analysts per Covered Firm Covered Firms per Analyst
Year No. of No. of As a % of Market Cap. As No. of No. of Average
Listed Firms Covered Firms Listed Firms % of Market Mean Median Mean Median Brokers Analysts Rating
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

1985* 6,826 1,841 27.0 68.8 2.66 2 10 7 26 492 2.52

1986 7,281 2,989 41.1 85.3 4.25 3 13 10 61 960 2.37
1987 7,575 3,163 41.8 89.0 4.53 3 13 10 74 1,080 2.28
1988 7,573 3,226 42.6 90.5 4.75 3 13 10 96 1,171 2.32
1989 7,304 3,066 42.0 91.2 4.15 3 12 9 95 1,032 2.35
1990 7,138 3,105 43.5 92.3 4.50 3 13 10 98 1,082 2.34
1991 7,171 3,201 44.6 93.0 5.18 3 13 11 120 1,270 2.36
1992 7,459 3,546 47.5 93.8 5.09 3 12 10 131 1,452 2.23
1993 7,964 4,097 51.4 93.5 5.50 3 13 11 151 1,700 2.22
1994 8,494 4,611 54.3 93.9 5.61 3 13 11 169 2,007 2.09
1995 8,857 5,129 57.9 94.6 5.37 3 13 11 188 2,144 2.11
1996 9,408 5,628 59.8 95.6 5.27 3 13 11 195 2,367 2.04

Average
All Years 7,754 3,634 46.1 90.1 4.74 3 13 10 117 1,396 2.27
 Table II
Transition Matrix of Analyst Recommendations (Number, Median Days), 1985-1996
This table shows the number and the median days between changes in recommendations.The first row reports
all changes from a recommendation of 1 (strong buy) to 1, 2 (buy), 3 (hold), 4 (sell), 5 (strong sell) or
discontinuation of coverage, and the total across the columns. The sixth and seventh rows identify
recommendations for firms that were previously dropped from coverage and for firms for which coverage was
initiated in the database. Fractional recommendations are rounded to the nearest whole value.

To Recommendation of:
From Rec.: 1 2 3 4 5 Dropped Total
1 34,939 15,269 16,887 538 805 9,802 78,240
293 109 128 140 135 121
2 14,010 21,936 17,581 1,349 468 8,177 63,521
95 299 115 106 111 121
3 12,945 14,492 52,813 3,971 2,958 15,332 102,511
113 112 291 114 116 123
4 480 1,180 3,913 2,936 668 1,097 10,274
132 103 98 245 98 135
5 396 316 2,739 439 1,409 1,143 6,442
95 105 94 90 301 99
Dropped 4,951 3,507 5,999 546 400 5,013 20,416
73 65 92 102 110 59

First Zacks Rec. 26,053 19,817 24,458 2,392 1,531 5,965 80,216
Total 93,774 76,517 124,390 12,171 8,239 46,529 361,620

% of Total 25.9 21.2 34.4 3.4 2.3 12.9

% of Non-Drops 29.8 24.3 39.5 3.9 2.6 .

 Table III
Two Day Percentage Size-Adjusted Returns Associated with Announcements of
Changes in Analyst Recommendations, 1985-1996
This table shows the percentage size-adjusted returns measured for the day before and the day of changes in analyst recommendations. For example, the first row
reports the returns associated with all changes from a recommendation of 1 (strong buy) to 2 (buy), 3 (hold), 4 (sell), 5 (strong sell), or discontinuation of
coverage. Returns are measured as the two-day buy and hold return less the two-day buy and hold return for firms in the same size decile, based on NYSE firms
market capitalizations. The sixth and seventh rows show the returns associated with recommendations for firms that were previously dropped from coverage,
and for firms for which coverage was initiated, respectively. Fractional recommendations are rounded to the nearest whole value. t-statistics, estimated using
cross-sectional standard errors, are shown below the returns. Each t-statistic pertains to the hypothesis that the mean size-adjusted abnormal return is zero. (The
number of observations in each cell is shown in Table 2.)

From To Recommendation of:

Recommendation: 1 2 3 4 5 Dropped
1 -0.749 -1.871 -0.999 -2.518 -0.027
-16.58 -30.92 -3.529 -6.008 -0.602

2 0.810 -1.168 -0.482 -1.351 0.917

19.33 -23.52 -2.611 -3.138 2.102

3 1.173 0.822 -0.744 -0.709 0.104

25.31 20.60 -8.246 -4.878 2.900

4 0.600 0.423 0.454 -0.537 0.195

3.209 3.499 5.958 -2.427 1.318

5 0.354 1.150 0.267 -0.102 0.223

1.422 4.961 2.707 -0.383 1.285

Dropped 0.503 0.246 -0.069 -0.758 -0.172

7.998 3.486 -1.291 -3.417 -0.619

First Zacks Rec. 0.808 0.346 -0.138 -0.213 -0.494 0.126

26.55 11.64 -5.189 -2.624 -3.931 2.484
 Table IV
Descriptive Characteristics for Portfolios Formed on the Basis of Analyst Recommendations, 1986-1996
This table presents descriptive statistics for several portfolios. The first five portfolios are based on the daily average analyst recommendation. Portfolios 1-
5 include stocks with average daily recommendations of [1-1.5], (1.5-2], (2-2.5], (2.5-3] and greater than 3, respectively. The difference between returns for
portfolios 1 and 5, and 2 and 4 are shown next. The 'All Covered' portfolio is the set of all stocks in portfolios 1-5, while the 'Neglected' portfolio consists of
all stocks on the daily CRSP returns file with no Zacks recommendations for a sample day. The final portfolio takes a long position in All Covered stocks
and a short position in Neglected stocks. The average monthly number of firms in each portfolio, the mean number of analysts per firm per day in that
portfolio, the average rating and the percent of total market capitalization represented by the firms in the portfolio is shown. Annual turnover is calculated
as the average percentage of the portfolios holdings as of the close of one day's trading that has been sold as of the close of trading on the next trading day,
multiplied by the number of trading days in the year.The coefficient estimates are those from a time series regression of the portfolio returns R( p-Rf) on
the market excess return (R m-Rf ), a zero-investment size portfolio (SMB), a zero-investment book-to-market portfolio (HML) and a zero-investment price
momentum portfolio ( PMOM). t-statistics appear below the coefficient estimates. Each t-statistic pertains to the null hypothesis that the associated
coefficient is zero, except for the t-statistics on the coefficient estimate of R
( m-Rf) for portfolios 1-5, and the All Covered and Neglected portfolios, for
which the null hypothesis is that the coefficient is one. The t-statistics for coefficients that are significant at a level of 10% or better are shown in bold.

Monthly Avg Coefficient Estimates for the 4-Characteristic Model

Portfolio No. of Firms No. of Average % of % Annual Rm - R f SMB HML PMOM Adjusted
(min, max) Analysts Rating Market Cap. Turnover R-squared
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)

1 (Most Favorable) 760 2.35 1.24 8.5 456 1.055 0.214 -0.313 0.010 94.0
(189, 1759) 1.881 4.304 -5.408 0.215

2 810 3.61 1.85 29.7 425 1.030 -0.020 -0.155 0.025 98.2
(391, 1396) 2.064 -0.794 -5.377 1.049

3 646 4.93 2.29 34.2 454 0.988 -0.060 0.070 0.056 98.6
(237, 948) 1.055 -3.110 3.118 3.023

4 804 3.21 2.80 17.6 475 0.958 0.017 0.232 -0.022 95.8
(522, 1046) 2.267 0.538 6.221 -0.737

5 (Least Favorable) 211 3.58 3.52 3.0 476 0.960 0.260 0.279 -0.293 88.3
(115, 317) 1.204 4.556 4.213 -5.407

P1-P5 971 NA NA NA 932 0.095 -0.046 -0.592 0.303 47.2

(375, 1876) 1.980 -0.552 -6.221 3.893

P2-P4 1614 NA NA NA 900 0.072 -0.037 -0.386 0.047 42.8

(919, 2330) 2.500 -0.746 -6.729 1.003

All Covered 3231 3.22 2.21 92.1 12 0.994 0.001 -0.004 0.015 99.9
(1554, 5146) 1.698 0.119 -0.607 2.682

Neglected 3932 NA NA 9.7 70 0.934 0.402 0.276 -0.024 94.9

(3537, 4705) 3.120 11.161 6.554 -0.698

All Covered- 7163 NA NA NA 82 0.060 -0.402 -0.280 0.039 60.9

Neglected (6259, 8781) 2.760 -10.744 -6.441 1.095
 Table V
Percentage Monthly Returns Earned by Portfolios Formed on the Basis of Analyst Recommendations, 1986-1996
This table presents percentage monthly returns earned by portfolios formed according to average analyst recommendation. Raw
returns are the mean percentage monthly returns earned by each portfolio. Market-adjusted returns are the mean raw returns less the
return on a value weighted NYSE/ASE/NASDAQ index. The CAPM intercept is the estimated intercept from a time-series
regression of the portfolio return R( p-Rf) on the market excess return (Rm-Rf). The intercept for theFama-French three-factor model
is the estimated intercept from a time-series regression of the portfolio return on the market excess return( Rm-Rf), a zero-
investment size portfolio (SMB), and a zero-investment book-to-market portfolio (HML). The four-characteristic intercept is
estimated by adding a zero-investment momentum portfolio (PMOM) as an independent variable. Each t-statistic pertains to the null
hypothesis that the associated return is zero. The t-statistics for returns that are significant at a level of 10% or better are shown in bold.

Portfolio Mean Mean Intercept from

Raw Return Market-Adjusted Four-
Return CAPM Fama-French Characteristic
(1) (2) (3) (4) (5) (6)

1 (Most Favorable) 1.576 0.351 0.201 0.352 0.344

2.472 1.475 3.167 2.930

2 1.495 0.270 0.184 0.229 0.210

3.999 2.976 4.140 3.605

3 1.263 0.038 0.029 -0.006 -0.049

0.763 0.592 -0.132 -1.076
4 1.121 -0.103 -0.053 -0.124 -0.107
-1.180 -0.640 -1.729 -1.409

5 (Least Favorable) 0.558 -0.667 -0.599 -0.637 -0.409

-3.908 -3.502 -4.513 -3.044

P1-P5 1.018 1.018 0.800 0.989 0.753

4.160 4.160 3.495 5.113 3.900

P2-P4 0.374 0.374 0.236 0.354 0.317

2.630 2.630 1.813 3.193 2.719

All Covered 1.306 0.081 0.053 0.055 0.043

6.432 3.994 4.102 3.150

Neglected 0.890 -0.334 -0.277 -0.273 -0.254

-2.799 -2.245 -3.371 -2.977

All Covered- 0.416 0.416 0.330 0.328 0.298

Neglected 3.200 3.200 2.606 3.910 3.374
 Table VI
Percentage Monthly Returns Earned by Portfolios Formed on the Basis of Analyst Recommendations and Size, 1986-1996
This table presents the percentage monthly returns earned by portfolios formed by average analyst recommendations, and by size. The large (small) firm
sample, B (S), includes firms with market capitalizations in the top (bottom) 30 percent of NYSE firms. The medium-sized firm sample, M, includes firms
with market capitalizations between the 30th and 70th percentile of NYSE firms. Raw returns are the mean percentage monthly returns earned by each
portfolio. (Underneath each of the raw returns for portfolios 1- 5, and the All Covered and Neglected portfolios is the average monthly number of firms in that
portfolio.) Market-adjusted returns are the mean raw returns less the return on a value weighted NYSE/ASE/NASDAQ index. The CAPM intercept is the
estimated intercept from a time-series regression of the portfolio return R( p-Rf) on the market excess return (Rm-Rf). The intercept for the Fama-French three-
factor model is the estimated intercept from a time-series regression of the portfolio return on the market excess returnR(m-Rf), a zero-investment size
portfolio (SMB), and a zero-investment book-to-market portfolio (HML). The four-characteristic intercept is estimated by adding a zero-investment
momentum portfolio (PMOM) as an independent variable. Each t-statistic pertains to the null hypothesis that the associated return is zero. The t-statistics for
returns that are significant at a level of 10% or better are shown in bold.
Portfolio Mean Raw Return Mean Market- Intercept from
Adjusted Return CAPM Fama-French Four-Characteristic
S M B S M B S M B S M B S M B
1 (Most Favorable) 1.800 1.654 1.468 0.575 0.430 0.244 0.377 0.298 0.099 0.682 0.495 0.141 0.575 0.387 0.251
560 114 17 2.283 2.253 1.213 1.503 1.530 0.508 6.748 3.586 0.755 5.615 2.715 1.293

2 1.478 1.589 1.482 0.253 0.365 0.257 0.107 0.211 0.193 0.355 0.347 0.202 0.327 0.226 0.212
475 216 95 1.155 2.557 2.843 0.482 1.525 2.222 4.114 3.542 2.752 3.602 2.314 2.730

3 1.253 1.309 1.270 0.029 0.084 0.045 -0.138 -0.021 0.070 0.055 0.039 0.005 -0.004 -0.027 -0.022
261 238 141 0.142 0.837 0.561 -0.671 -0.211 0.923 0.552 0.512 0.078 -0.041 -0.347 -0.366

4 0.796 1.061 1.200 -0.429 -0.164 -0.025 -0.460 -0.174 0.064 -0.351 -0.174 -0.057 -0.275 -0.169 -0.032
523 200 72 -2.363 -1.585 -0.193 -2.402 -1.597 0.536 -4.814 -2.100 -0.571 -3.717 -1.932 -0.305

5 (Least Favorable) 0.040 0.675 0.716 -1.184 -0.550 -0.508 -1.227 -0.585 -0.310 -1.153 -0.634 -0.395 -0.926 -0.596 -0.017
139 59 12 -4.234 -2.960 -1.818 -4.212 -3.015 -1.172 -6.279 -4.140 -1.496 -5.057 -3.695 -0.066

P1-P5 1.759 0.979 0.752 1.759 0.979 0.752 1.604 0.883 0.409 1.836 1.129 0.535 1.502 0.984 0.268
6.893 4.025 2.040 6.893 4.025 2.040 6.396 3.608 1.199 8.570 5.382 1.644 7.302 4.516 0.799

P2-P4 0.682 0.528 0.282 0.682 0.528 0.282 0.567 0.385 0.129 0.706 0.521 0.259 0.603 0.395 0.244
4.986 3.780 1.627 4.986 3.780 1.627 4.386 3.052 0.793 6.528 4.902 1.763 5.452 3.711 1.569

All Covered 1.275 1.308 1.320 0.051 0.084 0.096 -0.075 -0.006 0.098 0.142 0.074 0.055 0.129 0.016 0.065
1957 827 339 0.251 0.803 1.668 -0.359 -0.058 1.897 2.683 1.099 2.206 2.306 0.237 2.481

Neglected 0.682 0.998 1.143 -0.543 -0.227 -0.081 -0.451 -0.122 -0.106 -0.395 -0.124 -0.208 -0.326 -0.173 -0.179
3379 140 19 -2.830 -1.777 -0.450 -2.302 -1.003 -0.572 -4.262 -1.201 -1.156 -3.400 -1.600 -0.941

All Covered- 0.594 0.310 0.177 0.594 0.310 0.177 0.376 0.116 0.203 0.537 0.198 0.264 0.455 0.190 0.244
Neglected 3.630 2.145 0.954 3.630 2.145 0.954 2.822 0.990 1.077 5.147 1.776 1.421 4.222 1.612 1.248
 Table VII
Percentage Monthly Returns Earned by Portfolios Formed on the Basis of Analyst Recommendations and Sample Period, 1986-1996
This table presents the percentage monthly returns earned by portfolios formed by average analyst recommendations and by sample periods, 1986-
1990 and 1991-1996. Raw returns are the mean percentage monthly returns earned by each portfolio. Market-adjusted returns are the mean raw
returns less the return on a value weighted NYSE/ASE/NASDAQ index. The CAPM intercept is the estimated intercept from a time-series
regression of the portfolio return (Rp-Rf) on the market excess return ( Rm-Rf). The intercept for the Fama-French three-factor model is the
estimated intercept from a time-series regression of the portfolio return on the market excess return ( Rm-Rf), a zero-investment size portfolio
(SMB), and a zero-investment book-to-market portfolio (HML). The four-characteristic intercept is estimated by adding a zero-investment
momentum portfolio (PMOM) as an independent variable. Each t-statistic pertains to the null hypothesis that the associated return is zero. The t-
statistics for returns that are significant at a level of 10% or better are shown in bold.

Portfolio Mean Mean Market- Intercept from

Raw Return Adjusted Return CAPM Fama-French Four-Characteristic
86-90 91-96 86-90 91-96 86-90 91-96 86-90 91-96 86-90 91-96
1 (Most Favorable) 1.280 1.822 0.274 0.416 0.162 0.117 0.232 0.205 0.246 0.118
1.490 1.965 0.954 0.560 1.484 1.330 1.431 0.734

2 1.254 1.695 0.248 0.289 0.164 0.149 0.136 0.211 0.101 0.175
2.384 3.240 1.808 1.755 1.874 2.557 1.276 2.019

3 1.117 1.339 0.111 -0.023 0.063 0.012 0.001 0.035 -0.041 -0.020
1.536 -0.332 0.843 0.171 0.020 0.565 -0.570 -0.316

4 0.962 1.254 -0.045 -0.152 -0.061 0.001 -0.014 -0.103 -0.009 -0.042
-0.325 -1.350 -0.459 0.012 -0.119 -1.142 -0.069 -0.456

5 (Least Favorable) 0.170 0.881 -0.837 -0.525 -0.817 -0.484 -0.601 -0.743 -0.381 -0.440
-3.043 -2.462 -3.106 -2.107 -2.755 -3.775 -1.667 -2.494

P1-P5 1.110 0.941 1.110 0.941 0.979 0.601 0.833 0.948 0.627 0.558
2.861 3.003 2.861 3.003 2.801 1.909 2.901 3.383 2.032 2.143

P2-P4 0.293 0.441 0.293 0.441 0.225 0.148 0.150 0.314 0.110 0.218
1.334 2.369 1.334 2.369 1.114 0.859 0.931 2.067 0.620 1.381

All Covered 1.103 1.475 0.097 0.0689 0.042 0.047 0.031 0.055 0.014 0.038
4.609 4.506 2.005 2.939 1.428 3.398 0.590 2.351

Neglected 0.589 1.142 -0.417 -0.265 -0.440 -0.032 -0.165 -0.252 -0.134 -0.210
-2.451 -1.583 -2.462 -0.185 -1.449 -2.139 -1.076 -1.689

All Covered- 0.514 0.334 0.514 0.334 0.483 0.079 0.196 0.307 0.148 0.248
Neglected 2.741 1.851 2.741 1.851 2.607 0.457 1.652 2.596 1.142 1.998
 Table VIII
Percentage Monthly Returns Earned by Portfolios Formed on the Basis of Analyst Recommendations, for Bear and Bull Market Months, 1985-1996
This table presents the percentage monthly returns earned by portfolios formed by average analyst recommendations, for bull and bear market months. A bull
(bear) market month is one in which the CRSP value-weighted return is positive (negative). Approximately 68% (32%) of sample months are classified as bull
(bear) market. Raw returns are the mean percentage monthly returns earned by each portfolio. Market-adjusted returns are the mean raw returns less the return
on a value weighted NYSE/ASE/NASDAQ index. The bull and bear market intercepts for each model are estimated from a common regression that includes an
indicator variable to differentiate between markets. The CAPM intercepts are derived from a time-series regression of the portfolio return (Rp-Rf) on the market
excess return (Rm-Rf). The intercepts for the Fama-French three-factor model are derived from a time-series regression of the portfolio return on the market
excess return (Rm-Rf), a zero-investment size portfolio (SMB), and a zero-investment book-to-market portfolio (HML). The four-characteristic intercepts are
derived by adding a zero-investment momentum portfolio (PMOM) as an independent variable. Each t-statistic pertains to the null hypothesis that the associated
return is zero. The t-statistics for returns that are significant at a level of 10% or better are shown in bold. An asterisk (double asterisk) denotes a bear market intercept
that is significantly different from the corresponding bull market intercept at the 1% (10%) level.
Portfolio Mean Mean Market- Intercepts from
Raw Return Adjusted Return CAPM Fama-French Four-Characteristic

1 (Most Favorable) -3.472 3.932 -0.286 0.649 0.337 0.116 0.301 0.385 0.294 0.377
-1.494 3.595 1.148 0.549 1.270 2.215 1.229 2.100
2 -3.264 3.716 -0.078 0.433 0.198 0.175 0.177 0.263 0.161 0.242
-0.744 5.350 1.486 1.820 1.500 3.038 1.359 2.720
3 -3.096 3.296 0.090 0.014 -0.019 0.059 -0.015 0.000 -0.050 -0.049
1.077 0.220 -0.182 0.775 -0.155 0.000 -0.537 -0.696

4 -2.836 2.968 0.349 -0.314 0.039 -0.110 0.070 -0.248 0.083 -0.230
2.618 -2.991 0.218 -0.856 0.459 -2.226 0.542 -2.002
5 (Least Favorable) -3.453 2.430 -0.267 -0.853 -0.794 -0.478 -0.739 -0.572 -0.553 -0.316
-0.772 -4.505 -2.153 -1.798 -2.461 -2.592 -2.020 -1.543

P1-P5 -0.019 1.502 -0.019 1.502 1.131 0.594 1.040 0.957 0.847 0.693
-0.046 5.199 -0.046 5.199 2.294 1.672 2.524 3.164 2.151 2.350
P2-P4 -0.428 0.747 -0.428 0.747 0.159 0.284 0.107 0.511 0.079 0.472
-1.985 4.424 -1.985 4.424 0.566 1.403 0.457 2.966 0.332 2.663

All Covered -3.139 3.381 0.046 0.098 0.047 0.056 0.046 0.061 0.037 0.048
2.015 6.554 1.660 2.738 1.618 2.892 1.309 2.268
** * **
Neglected -2.873 2.647 0.313 -0.636 0.121 -0.525 0.164 -0.552 0.177 -0.534
1.399 -4.906 0.569 -2.764 0.980 -4.504 1.048 -4.230

All Covered- -0.267 0.734 -0.267 0.734 -0.073** 0.582 -0.117* 0.612 -0.139* 0.581
Neglected -1.091 5.182 -1.091 5.182 -0.272 2.983 -0.678 4.822 -0.803 4.456
 Table IX

Percentage Monthly Returns Earned by Portfolios Formed on the Basis of Analyst Recommendations, by Delay in Investment, 1986-1996
This table presents percentage monthly returns earned by portfolios formed by average analyst recommendation, where investment is delayed
beyond the close of trading on the date the average recommendation changes. Panel A presents the results for a one day delay, Panel B for a 15 day
delay, and Panel C for a 30 day delay. Raw returns are the mean percentage monthly returns earned by each portfolio. Market-adjusted returns are
the mean raw returns less the return on a value weighted NYSE/ASE/NASDAQ index. The CAPM intercept is the estimated intercept from a time-
series regression of the portfolio return (Rp-Rf) on the market excess return (Rm-Rf). The intercept for the Fama-French three-factor model is the
estimated intercept from a time-series regression of the portfolio return on the market excess returnR(m-Rf), a zero-investment size portfolio
(SMB), and a zero-investment book-to-market portfolio (HML). The four-characteristic intercept is estimated by adding a zero-investment
momentum portfolio (PMOM) as an independent variable.Each t-statistic pertains to the null hypothesis that the associated return is zero. The t-
statistics for returns that are significant at a level of 10% or better are shown in bold.

Panel A: Portfolios formed 1 day after average recommendation changes

Portfolio Mean Mean Market- Intercept from
Raw Return Adjusted Return Four
CAPM Fama-French Characteristic

1 (Most Favorable) 1.545 0.321 0.162 0.318 0.301

2.197 1.168 2.819 2.525

2 1.439 0.234 0.150 0.193 0.180

3.503 2.457 3.470 3.067

3 1.246 0.021 0.013 -0.021 -0.067

0.431 0.263 -0.452 -1.466

4 1.137 -0.087 -0.039 -0.110 -0.093

1.011 -0.475 -1.542 -1.241

5 (Least Favorable) 0.578 -0.647 -0.582 -0.618 -0.399

-3.860 -3.457 -4.505 -3.046

P1-P5 0.968 0.968 0.744 0.935 0.700

3.948 3.948 3.262 4.896 3.672

P2-P4 0.322 0.322 0.189 0.302 0.273

2.292 2.292 1.459 2.730 2.336
 Table IX (Continued)

Panel B: Portfolios formed 15 days after average recommendation changes

Portfolio Mean Mean Market- Intercept from

Raw Return Adjusted Return Four
CAPM Fama-French Characteristic

1 (Most Favorable) 1.407 0.181 0.034 0.177 0.181

1.273 0.249 1.524 1.478

2 1.336 0.112 0.017 0.064 0.041

1.482 0.253 1.032 0.627

3 1.310 0.084 0.074 0.039 0.008

1.702 1.530 0.873 0.179

4 1.183 -0.041 0.016 -0.050 -0.043

-0.489 0.206 -0.735 -0.590

5 (Least Favorable) 0.809 -0.042 -0.359 -0.403 -0.223

-2.541 -2.170 -3.008 -1.693

P1-P5 0.599 0.599 0.393 0.580 0.404

2.467 2.467 1.716 3.015 2.054

P2-P4 0.153 0.153 0.001 0.114 0.084

1.061 1.061 0.009 1.023 0.710
 Table IX (Continued)

Panel C: Portfolios formed 30 days after average recommendation changes

Portfolio Mean Mean Market- Intercept from

Raw Return Adjusted Return Four
CAPM Fama-French Characteristic

1 (Most Favorable) 1.282 0.056 -0.081 0.077 0.084

0.386 -0.566 0.659 0.681

2 1.338 0.114 0.024 0.065 0.048

1.657 0.385 1.154 0.807

3 1.334 0.109 0.103 0.070 0.020

2.097 1.963 1.428 0.394
4 1.197 -0.028 0.029 -0.037 -0.005
-0.337 0.377 -0.558 -0.065

5 (Least Favorable) 0.854 -0.373 -0.331 -0.388 -0.229

-2.329 -2.032 -3.234 -1.940

P1-P5 0.429 0.429 0.251 0.465 0.313

1.797 1.797 1.090 2.539 1.662

P2-P4 0.142 0.142 -0.005 0.102 0.052

1.022 1.022 -0.040 0.948 0.463
 Figure 1
Cumulative Percentage Market-Adjusted Return Earned by Portfolios Formed on the
60
Basis of Analyst Recommendations

P1 (Most Favorable)
P2
40
P3
P4
20 P5 (Least Favorable)

-20

-40

-60

-80

-100
8601

8605

8609

8701

8705

8709

8801

8805

8809

8901

8905

8909

9001

9005

9009

9101

9105

9109

9201

9205

9209

9301

9305

9309

9401

9405

9409

9501

9505

9509

9601

9605

9609
Month
 Figure 2
Annualized Percentage Excess Return (percentage monthly excess returns multiplied by 12) Earned
by Portfolios Formed on the Basis of Analyst Recommendations, 1986-1996

10.0

8.0 Market-Adjusted
CAPM
6.0 Fama-French
Four Characteristic
4.2 4.2 4.1
4.0 3.2
2.8
2.4 2.5
2.2
2.0
0.5 0.4

0.0
-0.1
-0.6 -0.6
-1.2 -1.3
-2.0 -1.5

-4.0

-4.9
-6.0

-7.2
-8.0 -7.6
-8.0

-10.0

1 (Most 2 3 4 5 (Least
Favorable) Favorable)
 Figure 3
Sum of Percentage Monthly Return Earned by Portfolios Formed on the Basis of
Analyst Recommendations, by Year, 1986 - 1996
28

P1 minus P5
23
P2 minus P4

All Covered minus Neglected

18

13

-2

-7

-12
86 87 88 89 90 91 92 93 94 95 96
Year
 Figure 4
Cumulative Percentage Market-Adjusted Return Earned by Portfolio 1 (Most Favorable) and
Portfolio 5 (Least Favorable)
60 Portfolios formed 0, 1, 15, and 30 days after change in average recommendation
+1
+0
40

P1 (Most Favorable) + 15 + 30
20

+ 30
-20
P5 (Least Favorable)

-40

+ 15

-60
+1

-80 +0

-100
8601

8605

8609

8701

8705

8709

8801

8805

8809

8901

8905

8909

9001

9005

9009

9101

9105

9109

9201

9205

9209

9301

9305

9309

9401

9405

9409

9501

9505

9509

9601

9605

9609
Month