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Analyst Long-term Growth Forecasts, Accounting Fundamentals and Stock Returns

In this working paper, authors, Gregg S. Fisher, Ronnie Shah, and Sheridan Titman, decompose consensus analyst long-term growth forecasts into a hard growth component that captures accounting information (asset and sales growth, profitability and equity dilution) and an orthogonal soft growth component. The soft component does not forecast future returns, and the hard component does forecast future returns, but in a perverse way. Specifically, stocks with accounting information indicating favorable long-term growth forecasts tend to realize negative future excess returns. This and other evidence we present is consistent with biased long-term growth forecasts generating stock mispricing.

I. Introduction

The Gordon growth model expresses a stock’s price as a function of its current dividends, a discount rate, and long-term growth expectations. Of the three relevant components of price, determining long-term growth expectations. Of the three relevant components of price, determining long-term growth expectations requires the most judgement and is the most likely to be subject to systematic mistakes. This paper analyzes potential errors in long-term growth expectations by examining the long-term consensus (mean) forecasts of earnings reported by sell-side analysts.

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