Buy-and-hold abnormal return for portfolios ranked by ∆TP/P

4.0

3.21

3.0 2.65

1.89

1.82

2.0 1.60

Market-Adjusted Return

1.06

0.57 1.43

1.0

1.30

1.18 1.03

0.99

0.73

-0.19

0.0

0.22

-0.78

-1.0

-1.66

-1.30

-2.0

-3.0

-2.88

-4.0

-3.96

-5.0

Lowest 2 3 4 5 6 7 8 9 Highest

Portfolios deciles by target price level/revision

Figure 1. Average buy-and-hold abnormal return around announcements of target

prices.This ¢gure depicts average buy-and-hold abnormal returns for the period from two

days prior to through two days subsequent to the announcement of target price for decile

portfolios ranked on the basis of two target price information measures. Abnormal re-

turns are computed as the di¡erence between the ¢rm buy and hold return and the buy

and hold return on the NYSE/AMEX/Nasdaq value weight index.The information content

measures are (a) the ratio of target price to preannouncement stock price (stock price out-

standing two days prior to the announcement of the target price), denoted (TP/P), and (b)

the change in the individual brokerage house target price scaled by preannouncement

stock price, denoted (DTP/P).To avoid a possible cross-correlation problem caused by iden-

tical return observations, we delete all but one of identical return observations within

each portfolio.

The visual evidence in Figure 1 indicates that average abnormal returns

around target price revisions are increasing in the favorableness of the

target price and its revision. For example, the average abnormal return for port-

folios ranked on the basis of the ratio of announced target price to the stock

price outstanding two days prior to the announcement, TP/P, ranges from an

average of À 1.66 percent for the least favorable target price revision to 1.03

percent for the most favorable one. A larger spread in abnormal returns is asso-

ciated with portfolios ranked on the basis of the revision in the individual broker-

age house target price, with average abnormal returns ranging from À 3.96

percent to 3.21 percent for the least and most favorable revisions, respectively.

1944 The Journal of Finance

While unreported, di¡erences in average abnormal returns are highly statisti-

cally signi¢cant.11

Combining these ¢ndings with those in the extant literature of a signi¢cant

positive (negative) price reaction to favorable (unfavorable) stock recommenda-

tions (e.g., Stickel (1995), Womack (1996)) and earnings forecast revisions (Givoly

and Lakonishok (1979), Elton, Gruber, and Gultekin (1981), Lys and Sohn (1990),

Francis and So¡er (1997)) provides preliminary evidence that investors perceive

analyst price targets as informative signals regarding a ¢rm™s value. Further-

more, it raises an interesting question regarding the incremental information

content of target prices in the presence of recommendation and earnings forecast

revisions. We therefore extend our analysis, in Section II.B, below, to determine

whether target price revisions are incrementally informative.

B. Informativeness of Target Prices Conditional on Stock Recommendation and

Earnings Forecast Revisions

Table III provides regression results relating event-day abnormal returns to re-

commendation changes, earnings forecast revisions, and the target price revi-

sion measure DTP/P. We begin by regressing event-day abnormal returns (AR)

on three recommendation revision categories, earnings forecast revision, DF/P,

and target price revision DTP/P.12 Our goal is to determine whether target price

revisions are informative, controlling for recommendation and earnings forecast

revisions. The regression takes the form

AR ¼ a1 UPGRADES þ a2 DOWNGRADES þ a3 REITERATIONS

DF DTP

þb þg þe °1Þ

P P

where the indicator variablesFUPGRADES, DOWNGRADES, REITERA-

TIONSFtake the value 1 if the stated recommendation revision is met and 0

otherwise.

The regression results reported in column 1 of Panel A indicate that target

price revisions are positively and signi¢cantly related to event-day abnormal re-

turns (g ¼ 3.705 with t-statistic ¼ 38.7), controlling for the information in the asso-

ciated stock recommendation and earnings forecast revisions. Economically, a

11

In unreported results we perform two robustness tests. In the ¢rst, we examine whether

earnings announcements drive the documented average returns around target price an-

nouncements. Toward this end, we exclude from the abnormal return calculation observations

that fall within a ¢ve-day window of an earnings announcement. The results are qualitatively

the same. (This result is also consistent with Womack (1996), who ¢nds that the majority of

recommendation changes are not in response to earnings releases.) In the second test, to ac-

count for the possibility that the documented abnormal return is caused by other ¢rm-speci¢c

events immediately prior to the target price announcement, we calculate abnormal returns

starting at day 0 through day þ 2. The results remain unchanged.

12

We exclude from the analysis sell or strong sell recommendations because of the small

number of such observations.

Table III

Relative Informativeness of Analyst Target Price, Stock Recommendation, and Earnings Forecast Revisions

The sample consists of all target price announcements between January 1997 and December 1999. The table reports regression results in which

the dependent variable is the market-adjusted buy-and-hold abnormal return around target price announcements and the independent variables

are indicator variables for analyst recommendations, target prices, and earnings forecast revisions. The recommendation indicator variables

An Empirical Analysis of Analysts™ Target Prices

assume the value of 1 for the relevant recommendation revisions and 0 otherwise. The recommendation categories are upgrades, downgrades,

and reiterations.We also report p-values of tests of equality of the regression coe„cients. Abnormal return is computed as the di¡erence between

the ¢rm buy-and-hold return and the buy-and-hold return on the NYSE/AMEX/Nasdaq value-weight index over the period beginning two days

prior to and ending two days subsequent to the target price announcement. Earnings forecast revision is computed as the percentage change in

the brokerage house current and prior annual earnings forecast scaled by the preannouncement stock price.Target price revision is measured as

the change in the brokerage house target price, scaled by the preannouncement stock price.We winsorize the earnings forecast and target price

revision variables at the 1st and 99th percentiles to mitigate the possible e¡ect of extreme observations and verify that regression results are not

sensitive to in£uential observations.

Direction of Recommendation Revision Sign of Target Price Revision

Variable All Observations Upgrades Downgrades Reiterations Positive Negative Zero

(1) (2) (3) (4) (5) (6) (7)

a1 (Recommendation upgrade indicator) 2.966 2.702 4.311 0.919 1.210

21.3 18.6 25.7 2.7 3.7

À 3.001 À 2.493 À 6.357 À 1.799

a2 (Recommendation downgrade indicator) 0.048

À 20.5 À 15.9 À 26.8 À 5.9

0.2

À 1.510

a3 (Recommendation reiteration indicator) 0.375 0.376 1.571 0.132

À 16.2

12.1 12.1 29.0 2.7

b (Earnings forecast revision) 1.103 1.078 0.967 1.093 1.018 0.932 1.033

30.8 4.8 7.9 28.7 12.7 17.4 15.8

F

g (Price target revision) 3.705 6.278 8.094 3.330 1.787 0.678

F

38.7 14.8 18.1 33.1 12.9 3.1

Adjusted R2 5.5% 6.6% 13.2% 3.2% 9.5% 11.5% 1.1%

N 70,852 3,176 2,896 64,780 27,561 17,239 26,052

1945

(continued )

1946

Table III Continued

p-values of Tests of Equality of Regression Coe„cients

All Observations Recommendation Revision Target Price Revision

(Column 1) (Columns 2 ^ 4) (Columns 5 ^7)

a1 ¼ a2 ¼ a3 0.000

b(Upgrade) ¼ b(Downgrade) ¼ b(Reiteration) 0.619

b(Upgrade) ¼ b(Reiteration) 0.948

b(Downgrade) ¼ b(Reiteration) 0.327

g(Upgrade) ¼ g(Downgrade) ¼ g(Reiteration) 0.000

g(Upgrade) ¼ g(Reiteration) 0.000

g(Downgrade) ¼ g(Reiteration) 0.000

The Journal of Finance

a1(Positive) ¼ a1(Negative) ¼ a1(Zero) 0.000

a2 (Positive) ¼ a2 (Negative) ¼ a2(Zero) 0.000

a3(Positive) ¼ a3(Negative) ¼ a3(Zero) 0.000

b(Positive) ¼ b(Negative) ¼ b(Zero) 0.382

g(Positive) ¼ g(Negative) 0.001

An Empirical Analysis of Analysts™ Target Prices 1947

one standard deviation increase in DTP/P increases the event-day abnormal

return by 0.783 n 3.705 ¼ 2.9 percent, on average. Moreover, it can be seen that

revisions in both earnings forecasts and stock recommendations are infor-

mative as well. The positive and signi¢cant coe„cient on DF/P indicates that

the information in the earnings forecast revisions is not completely subsumed

by either the target price revisions or the stock recommendations. The coe„-

cients a1, a2, and a3 and their expected ordering (a2oa3oa1) provide evidence that

these recommendation revisions are incrementally informative. We easily reject

the joint hypothesis that these parameters are equal with an F test (p-

valueo0.0001).

The regression results provide interesting evidence regarding the role that tar-

get prices and earnings forecast revisions play in the case of recommendation

reiterations. Earlier work (e.g., Barber et al. (2001)) has shown that recommenda-

tion reiterations are the least informative, as is evident in the economically small

magnitude of the intercept associated with recommendation reiterations

(a3 ¼ 0.375, t-statistic ¼ 12.1). In such reiterations, it appears that investors rely

mostly on the information conveyed by the target prices and the earnings forecast

revisions.13

Next, we investigate whether the regression resultsFand, in particular, the

conclusions regarding the role of target price revisionsFare sensitive to the type

of recommendation and target price revisions. For example, when controlling for

the information in earnings forecast revisions, is the market response to target

price revisions similar when recommendations are upgraded, reiterated, or

downgraded? Or, is the market response similar after positive and negative tar-

get price revisions? Toward this end, we conduct two more sets of regressions. In

the ¢rst, we condition on the direction of the recommendation revision (columns

2 ^ 4), whereas in the second we condition on the sign of the target price revision

(columns 5 ^7).

Consider ¢rst the regression results when we condition on the type of recom-

mendation revision (upgrades, downgrades, and reiterations). It can be seen that

target price revisions are associated with larger abnormal returns when analysts

issue recommendation downgrades (g ¼ 8.094, t-statistic ¼ 18.1) relative to either

reiterations or upgrades. Indeed, the coe„cient g associated with recommenda-

tion downgrades is signi¢cantly larger than the one associated with recommen-

dation upgrades or reiterations. The asymmetric reaction is consistent with

the view that, given analysts™ reluctance to issue unfavorable recommendation

13

In additional analysis, we estimate separate regressions similar to the one in column 1 for

each recommendation reiteration category. While the coe„cient estimates on the price target

and earnings forecast revision are signi¢cant and in the expected sign, the intercept estimate

(i.e., the average abnormal return), while economically small, is signi¢cant and positive for

both strong buy and buy reiterations and is signi¢cant and negative only for hold reiterations.

This ¢nding suggests that the positive coe„cient on recommendation reiterations in column 1

of Panel A is driven primarily by events in which recommendation reiterations were either

strong buy or buy. Further evidence on the role of recommendation revisions is given in the

Appendix.

1948 The Journal of Finance

revisions, investors perceive downgrades as a more credible signal.14 We also ¢nd

that bFthe slope on the earnings forecast revisionFis not statistically di¡erent

across the three recommendation revisions. Since an earnings forecast is a key

input to the derivation of the target price along with an assumed ¢nancial ratio

(Asquith et al. (2002)), this evidence suggests that when analysts issue a recom-

mendation downgrade, investors view the chosen magnitude of the ¢nancial ra-

tio (i.e., multiple) as more informative.

In our second set of regressions, we repeat the same analysis as above but now

condition on the sign of target price revision (columns 5 ^7). Our goal is to gain

further insight into the relation between abnormal returns and target price revi-

sions in these speci¢c settings.We ¢nd that the slope coe„cient of positive target

price revisions (column 5) is signi¢cantly larger (p-value ¼ 0.001) than that of ne-

gative revisions (column 6).15 We also ¢nd that the estimated slope coe„cients on

the earnings forecast revisions are similar across the three groups, consistent

with the results in columns 2 ^ 4.

Third, consider the intercept coe„cients that capture the average abnormal

return resulting from the recommendation revisions.These estimates provide in-

formation on the degree of consistency in investor reaction when revisions in re-

commendations and price targets are reinforcing or countervailing. As expected,

abnormal returns associated with recommendation upgrades (downgrades) are

economically and statistically the largest when such revisions coincide with po-

sitive (negative) target price revisions. For example, when target prices are re-

vised upward (column 5), a1, the intercept that captures the abnormal return

due to recommendation upgrades, equals 4.311 and is signi¢cantly larger than