ANALYSTS USE OF EARNINGS FORECASTS IN PREDICTING STOCK RETURNS - FORECAST HORIZON EFFECTS

Little attention has been paid to a principal decision context in whic h analysts' earnings forecasts are prepared, namely, as an input to th eir recommendations. We use two data sets, Value Line, USA, and Resear ch Evaluation Service, Canada, and examine the importance of analysts' earnings forecasts for their stock price forecasts via three hypothes es: (1) analysts' earnings forecasts are important for their stock pri ce forecasts; (2) analysts' long-term earnings forecasts are more impo rtant than their short-term earnings forecasts for their predictions o f stock prices over a particular stock price forecast horizon; (3) the importance of analysts' earnings forecasts for their stock price fore casts rises as the joint earnings and stock price forecast horizon inc reases. We show that: (1) when the earnings forecast horizon is the ne xt fiscal year, forecasted earnings explain only 30% of the variation in forecasted price; (2) the importance of forecasted earnings for for ecasted price rises as the earnings forecast horizon increases; (3) in the long run, (i.e. three to five years hence), forecasted earnings e xplain about 60% of the variation in forecasted price. Decision useful ness is an ex ante concept, but tests regarding the usefulness of earn ings for stock price generally have used actual (not expectational) da ta. Our evidence suggests that earnings expectations are decision usef ul, where the decision context is sell-side analysts' stock price fore casts. Our results are potentially important to users of sell-side ana lyst research reports. When a stock recommendation is accompanied only by short-run earnings forecasts, investors need to closely examine es timates of non-earnings variables to assess the quality of stock recom mendations. In contrast, when stock recommendations are accompanied by both short-run and long-run earnings forecasts, investors need to exa mine estimates of non-earnings information variables less closely.