Analyst Long-term Earnings Growth Forecasts and Stock Returns

Should investors buy stocks of companies for which analysts have issued very high earnings growth forecasts? In the March 2021 revision of their paper entitled “Diagnostic Expectations and Stock Returns”, flagged by a subscriber, Pedro Bordalo, Nicola Gennaioli, Rafael La Porta and Andrei Shleifer update and extend prior research on the relationship between analyst long-term earnings growth forecasts and future returns of associated stocks. They define long-term forecasts as expected annual increase in operating earnings over the next three to five years. To relate these forecasts to stock returns, they each December form ten equal-weighted portfolios by ranking stocks into tenths (deciles) based on annual geometric average forecasted long-term earnings growth. They hold these portfolios until the next December, rebalancing each back to equal weight monthly. They focus on the highest long-term growth (HLTG) and lowest long-term growth (LLTG) decile portfolios. Using analyst earnings growth forecasts since December 1981 for a broad sample of U.S. common stocks and associated stock returns since December 1978, all through December 2016, they find that:

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