Relation between Analysts’ Stock Recommendations, Valuation and Returns evidence from Stock exchange of Thailand / Athipong Puvarawuttipanich
42 leaves: tables
This paper tries to link between how analysts turning their own earnings forecasts into stock recommendations. If earnings forecasts reflect analysts’ expectation of the firms, analysts should use their own earnings forecasts to estimate value of the firms and use this estimated value to generate stock recommendations. I use three valuation models to transform earnings forecasts into estimated firm’s value, namely, 1) PEG valuation, 2) Residual income with fade-rate assumption in terminal value and 3) Residual income with perpetuity assumption in terminal value. The results provide evidence that the estimated value based on PEG valuation and Residual income with perpetuity assumption can explain analysts’ recommendations. However, the value based on Residual income with fade-rate assumption shows the contradictory prediction with the other two models. Surprisingly, residual income with fade-rate assumption can explain future excess returns on stocks better than the other two valuation models. I also find evidence that stock recommendations are positively related to future excess returns but a more detailed analysis indicates that this is due to buy or sell recommendations themselves not from the valuations estimates which explain recommendations. The assumptions of each valuation models point out that analysts largely depend on the valuation models which large part of estimated value depend on future expectation of earnings such as PEG valuation models or present value models which have high proportion of calculated value depended on earnings forecasts. But for valuation models which largely rely on current book value such as residual income with fade-rate assumptions in terminal value, analysts are less inclined to give a buy recommendation to stocks whose estimated value from this models are high.