The association of analysts’ cash flow forecasts with stock recommendation profitability

Abstract

Purpose The purpose of this paper is to examine whether analysts’ cash flow forecasts improve the profitability of their stock recommendations and whether the positive effect of cash flow forecasts on analysts’ stock recommendation performance varies with firms’ earnings quality. Design/methodology/approach To test the authors’ predictions, they identify a sample of 161,673 stock recommendations with contemporaneous earnings forecasts and/or cash flow forecasts and regress market-adjusted stock returns on a binary variable that proxies for the issuance of cash flow forecasts while controlling for contemporaneous earnings forecast accuracy, earnings quality, analysts’ forecast experience and capability and certain firm characteristics. The authors’ test results are robust to alternative measures of recommendation profitability, earnings quality and the use of recommendation revisions instead of recommendation levels. Findings The authors find that when analysts issue cash flow forecasts concurrently with earnings forecasts, their stock recommendations lead to higher profitability than when they only issue earnings forecasts, after controlling for analysts’ forecast capability. Moreover, the authors document that the contemporaneous positive relationship between cash flow forecasts and recommendations profitability is stronger for firms with low earnings quality than for firms with high earnings quality. The findings suggest that cash flow forecasts issued by analysts in response to market demand likely play a more important role in firm valuation than cash flow forecasts issued by analysts mainly because of supply-side considerations. Research limitations/implications Future research could build on these findings to conduct further investigation on the alternative incentives for analysts’ forecasts of sales growth and long-term growth rates. Practical implications These findings may also help investors to better assess the quality of analysts’ research outputs and to identify superior stock recommendations. Originality/value This study provides insight into the role of cash flow forecasts in firm valuation and adds fresh evidence to the debate on the usefulness of cash flow forecasts. It extends the stream of research on the characteristics of analyst forecasts and increases our knowledge about the role of analysts in the financial market.

The effect of profitability and bank size on firm value sustainability: The mediating role of capital structure

“…In addition, banks use working capital to provide a comfortable level of liquidity to ensure sustainability by increasing profitability (Aldubhani et al, 2022;Abdullah et al, 2022). The achievement desired by shareholders from banking operations is to maximize the profitability by utilizing the equity they have invested (Kamaliah, 2020 On the other hand, profit maximization is always what shareholders want the most with the expectation of receiving maximum dividends or share prices (Pan & Xu, 2020;Teixeira et al, 2021). When the banks make a profit, the management can distribute profits to shareholders through the return on investment, capital gains on bank shares, and dividends (Kurniati, 2019).…”

“…Separation of roles helps companies to be able to choose efficient business activities and provide reasonable incentives for employees and enable companies to maximize profits (Cancela et al, 2020). Therefore, the increased firm value reflects the bank's success in improving its financial performance (Pan & Xu, 2020).…”

Institutional investor heterogeneity and analyst recommendation: Malaysian evidence

“…Financial analysts, who are mostly industry professionals, are key players in the financial markets, acting as sophisticated information intermediaries between companies and investors. They follow public listed companies (PLCs) and disseminate information such as earnings forecasts, stock recommendations and target price via research reports (García-Sánchez et al, 2020Healy & Palepu, 2001;Imam & Spence, 2016;Pan & Xu, 2020;Su et al, 2020). Their stock recommendations and earnings forecasts are considered by executives as one of the most influential factors impacting their firms' stock prices (Graham et al, 2005).…”

Do Analysts’ Cash Flow Forecasts Improve Firm Value?

“…Thereby, we suggest an empirical basis for analysts to encourage issuing cash flow forecasts in terms of information disclosure. Also, our findings suggest that cash flow forecasts issued by analysts in response to market demand likely play a more important role in firm valuation than cash flow forecasts issued by analysts mainly because of supply-side considerations (Pan and Xu 2020).…”

“…Andrews et al (2018) find that good (bad) news forecast revisions reduce (increase) investors' perception of uncertainty about firm value, analysts do not appear to use changes in implied volatilities to shade their forecast revisions to good/bad news and dispersion of forecasts are a reasonable proxy for uncertainty about firm value as indicated by their correlation with implied volatilities. Pan and Xu (2020) find that when analysts issue cash flow forecasts concurrently with earnings forecasts, their stock recommendations lead to higher profitability than when they only issue earnings forecasts, after controlling for analysts' forecast capability. Moreover, they document that the contemporaneous positive relationship between cash flow forecasts and recommendations profitability is stronger for firms with low earnings quality than for firms with high earnings quality.…”