Do All-Stars Shine? Evaluation of Analyst Recommendations

Using a unique data set, we studied the performance of stock recommendations made by Wall Street Journal all-star analysts. We document that stocks recommended by the all-star analysts outperform benchmarks controlled for size and industry. Stocks recommended by analysts who focus on a single industry outperform those recommended by analysts covering multiple industries. We also document a herding behavior among analysts in an industry. Unlike previous studies that found superior analyst performance only for small-cap stocks, our results indicate that superior performance also exists for large-cap stocks. Whether recommendations of brokerage analysts have investment value has been a contentious issue for more than six decades. Some researchers have found that a portfolio of the most highly recommended stocks can provide an annual abnormal return of about 4 percent. The implementation of the strategy to achieve such results requires daily rebalancing, however, so annual turnover rates are enormous. In addition, such superior performance may be driven mainly by small-cap stocks, for which transaction costs are likely to be higher than for large-cap stocks.We examined a set of analysts likely to possess superior stock-picking skills. The Wall Street Journal (WSJ) and Zacks Investment Research of Chicago, Illinois, have been conducting an annual All-Star Analysts Survey since 1993. The survey is published in a special pull-out section of the WSJ each summer. This survey evaluates the performance of the stocks recommended by the senior industry analysts of a large number of brokerage houses during the previous calendar year. Each analyst is then ranked on the basis of performance within each industry. The top five performers in each industry are termed “all-stars,” and the WSJ publishes the profiles and stock picks of the top three all-stars. We report the results of our tests of the performance of these recommendations relative to size- and industry-matched control companies.We followed a naive buy-and-hold strategy of investing in all the stocks recommended by the all-stars identified and published in the WSJ. We found that the market responds positively and significantly to these recommendations on the day of their publication. We also found that stocks recommended by all-stars continued to outperform the control companies for holding periods of one year (250 trading days) and two years (500 trading days). The results indicate that the all-star industry analysts, on average, do indeed have a good understanding of the industries they follow and have superior stock-picking ability within their industries.To test whether the analysts who follow only one industry do better than those who cover multiple industries, we analyzed the performance of these two groups. We found that analysts who focus on one specific industry do better than analysts who cover multiple industries.We document a herding behavior among analysts in a specific industry. About 27 percent of all stocks in our sample were recommended by more than one analyst. We found that of the 1,158 recommended stocks in our sample, 843 were recommended by one all-star analyst, 245 were recommended by two analysts, and 70 were recommended by three or more analysts. We did not find significant differences in returns among the three groups. Most of the stocks in our sample were large-cap stocks; of the 1,158 stocks, 924 were in the top size deciles (Deciles 9 or 10) of the NYSE/Amex universe of stocks. Prior studies have indicated that superior performance of analyst-recommended stocks is confined to small companies. We found that the superior performance also exists for large companies. In particular, we report holding-period returns for the large-cap stocks of 4.78 percent for a holding period of one year and 5.58 percent for a holding period of two years. For the smaller companies, although the publication-day returns were 1.23 percent and significant, we did not find significant holding-period returns for one or two years.