Recommendation Revision Screen - Are Broker Upgrades worth listening out for?

Thursday, Jul 21 2011 by
5
Recommendation Revision Screen  Are Broker Upgrades worth listening out for

In Brief 

A momentum screen that looks for recent analyst recommendation upgrades, especially those "bold revisions" that move away from the broker consensus.

Background

Although investing on the basis of broker recommendation alone does not appear to be a successful strategy, research suggests that focusing on recent changes in broker recommendations is more fruitful, particularly in combination with other signals. Looking at the relative level of recommendations, rather than the absolute level, may help to eliminate the upward bias. It also ensures that the information is fresh, unlike recommendations which can be up to 6 months’ old.

Researchers have distinguished between bold revisions, i.e. ones that move away from the consensus and which may provide new information vs. herding revisions that merely move toward the consensus. The results indicate that “bold” revisions have a greater impact. It also seems that the most influential revisions tend to be "revisions issued contemporaneously with earnings forecasts, analysts with greater relative experience, and those with more accurate earnings estimates”. Growth firms, small firms, and high turnover firms are also apparently more likely to have influential stock recommendations

It’s unclear why this post-recommendation revision drift  phenomenon exists. Investor inattention is probably the most plausible explanation given that it appears greatest for stocks with smaller market capitalizations and with lowest analyst following. It  may be that recommendation changes captures new qualitative information that it takes time for the market to assimilate (e.g., managerial changes, strategic alliances, or other growth opportunities). An alternative theory is that the recommendations themselves cause the subsequent price effect through the publicity surrounding them. 

Definition of a Recommendation Revision Screen 

Based on various research papers, some indicative criteria for a Recommendation Revision Screen might be:

  • At least one net revision in the recommendation over the last month (or preferably the last week). Another option might be, say, a 5% or greater change in rating over past 4 weeks.
  • Market cap in the bottom half of the database (Jegadeesh found the strategy was more profitable for smaller firms) but above £15m to avoid “the long tail” of illiquid stocks

Possible additional filters:

  • Relatively low analyst coverage (there tends to be greater investor inattention and information dissemination may take longer).
  • Revision moves away from the consensus – a “bold revision”. This would involve specifying however that at least two or…

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Disclaimer:  

As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested.


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