Can Financial Analysts Identify Diamonds in the Rough? The Case of Loss-Reporting Firms

• In Event: Financial Accounting and Reporting III

Abstract

Investors face greater difficulty valuing loss-reporting than profit-reporting firms. Since losses can be due to very different factors (e.g., poor operating performance or investment in R&D), financial information is of limited use for valuing loss firms. We focus on analysts’ coverage decisions, because their earnings forecasts are less useful in valuing loss-reporting than profit-reporting firms. We find that firms with high “abnormal analyst following” are more likely to stay in business and have better future operating/return performance. Moreover, this association is stronger for loss firms than for profit firms. The market, however, does not seem to use this information when pricing loss firms: for loss firms a portfolio investment strategy based on abnormal analyst following can generate positive excess returns over 1-3 year windows. We conclude that analysts are more selective in their coverage of loss firms and abnormal following is useful for identifying loss firms with bright future prospects.

Authors

• Yao Tian, San Jose State University

• Donal Byard, CUNY-Baruch College

• Masako Darrough, CUNY-Baruch College