Can Investors Profit from the Prophets? Security Analyst Recommendations and Stock Returns


  • Brad Barber,

  • Reuven Lehavy,

  • Maureen McNichols,

  • Brett Trueman

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    • Barber is an associate professor at the Graduate School of Management, University of California, Davis; Lehavy is an assistant professor at the Haas School of Business, University of California, Berkeley; McNichols is a professor at the Graduate School of Business, Stanford University; and Trueman is the Donald and Ruth Seiler Professor of Public Accounting at the Haas School of Business, University of California, Berkeley. We thank Jeff Abarbanell, Sudipto Basu, Bill Beaver, George Foster, Charles Lee, Terry Odean, Sheridan Titman, Russ Wermers, Kent Womack, the editor, Rene Stulz, and participants at the October 1998 NBER (Behavioral Finance) conference, the ninth annual Conference on Financial Economics and Accounting at NYU, the Berkeley Program in Finance (Behavioral Finance) conference, Barclay's Global Investors, Baruch College, Mellon Capital Management, Stanford University, Tel Aviv University, the Universities of British Columbia, Florida, and Houston, and UCLA, for their valuable comments, and Zacks Investment Research for providing the data used in this study. Lehavy and Trueman also thank the Center for Financial Reporting and Management at the Haas School of Business and McNichols thanks the Financial Research Initiative of the Stanford Graduate School of Business for providing research support. All remaining errors are our own.


We document that purchasing (selling short) stocks with the most (least) favorable consensus recommendations, in conjunction with daily portfolio rebalancing and a timely response to recommendation changes, yield annual abnormal gross returns greater than four percent. Less frequent portfolio rebalancing or a delay in reacting to recommendation changes diminishes these returns; however, they remain significant for the least favorably rated stocks. We also show that high trading levels are required to capture the excess returns generated by the strategies analyzed, entailing substantial transactions costs and leading to abnormal net returns for these strategies that are not reliably greater than zero.