The core idea of the study is when there are large price swings there are two possible outcomes:
- The large price change is simply an aberration caused by noise and liquidity trades. In that case, it is likely that the price move will be followed by corrections and price reversals. (or)
- The large price change/swing is caused by new information. If that is the case, then it is likely that the price will drift in the same direction of price change in subsequent weeks.
The study considers a large price change is based on new information if within 5 days of the large price change, the analysts following that stock issues either a earnings forecast revision (or) price target revision. In other words, if there is an immediate reaction from analysts following this stock, then the price change is considered to be based on new information.
Side note: The study has some additional observations with respect to analyst revisions and large price changes that I found interesting -
- Majority of analysts do not revise their earnings and target price forecasts immediately following large price moves. In other words, most large price changes are not associated with new information and hence likely to reverse.
- When analysts revise, often the revisions are more likely to be in the same direction as the price swing i.e., positive large price swing trigger positive earnings forecast or target price revisions and vice versa.
- Analyst revisions are more often when trading volume around the price swings are high signifying arrival of new information.
- Short term reversals are far less likely for large negative-return days (compared to large positive-return days) especially when not accompanied by analyst forecasts.
- The study observes that there are about 10 times more earning forecast recommendation revisions and over 3 times more target price revisions than recommendation revisions. So using these will not omit too many signals.
- Another reason is, say there is a big price increase and analyst already has a "buy" or "strong buy" recommendation, then there is no reason to revise that recommendation. On other hand, this price increase may cause analyst to revise either earnings forecast or target price forecast.
Please find below some of the tables from the study heavily annotated with my comments...
Overall the gist of the above tables is - one can forecast better the subsequent stock price returns after large price shocks if one takes into consideration whether there are immediate analysts revisions and are the revisions in the direction or opposite of price shock direction.
In the next part, I will cover the rest of the paper i.e., the portfolios constructed based on these insights and those portfolios performance. If you cannot wait till my next post, you can find the link to full paper here.
Question to readers:
I find this study interesting. On other hand, I am just a retail trader and neither know any analyst nor paid any attention in past to their output etc. So I am curious to hear thoughts from people who are more experienced on couple things like (a) does your experience correlate with observations in this study (b) why & how do funds/professionals in general use analyst revisions?