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Earnings sentiment as an alternative to sell-side revisions

In this post we present results of a research paper which shows that using Earnings Sentiment is a better predictor of monthly returns than Sell-side Analysts' Revisions.




Country/Region: North America, USA

Asset Class: Equities

Investment Universe: Russell 1000

Research & Application Context:

Alt. Data Factor: Media earnings sentiment

Method of Data Integration: Standalone

Period of Analysis: 01/01/2002-01/07/2018

Investment Direction: Long

Avg. Holding Period: month(s)

Avg. Portfolio Size: 200 stocks

Investment Process

Underlying investment logic

Instead of relying only on Wall Street's Sell-side Earnings Revisions, use Earnings Sentiment indices sourced by a Sentiment data provider from published news articles which give a larger and more frequently updated panel of earnings estimates.

Testing Model

Compare the efficacy of these two different estimates by building two monthly rebalanced portfolios composed of the top quintile (20%) of Russell 1000 stocks ranked by trailing 3-month Sell Side Revisions and trailing 3-month Earnings Sentiment and measure the returns.

Main Results

The chart hows that stocks in the highest/lowest Earnings Sentiment quintile outperformed/underperformed the market by 1.0/0.5 percentage points (left grey and black bars), while stocks in the highest/lowest Sell-side Analysts' Earnings Revisions quintile outperformed/underperformed the market by 0.0/0.25 percentage points (rightmost grey and black bars). Exhibit 17: The chart shows that the correlation between the returns of the highest and lowest quintiles of Earnings Sentiment and corresponding quintiles of Sell-side Analysts' Earnings Revisions. Correlation is relatively low (0.6) for the high quintiles.

The research shows that for large cap US stocks in the period 2002-2018:

  • Earnings Sentiment measured over the last 3-months was more informative of the next month's market-adjusted return than trailing 3-month Sell-side Analysts' Earnings Revisions

  • Each month selecting the stocks in the highest Earnings Sentiment quintile outperformed the market by 1 percentage point/year versus 0 percentage points outperformance for stocks in the highest rank by Sell-side Earnings Revisions

  • There is only mild correlation between stocks in the highest monthly quintiles of Earnings Sentiment and Sell-side Analysts' Revisions

  • A long strategy based on selecting the top 20% of stocks by Earning Sentiment resulted in Yearly Return of 6.6% and Return per Holding Period of 0.54%

  • A long-short strategy based on selecting the top/bottom 20% of stocks by Earnings Sentiment resulted in Yearly Return of 1.5%

Remarks & Conclusion

In 2002-2018 Earnings Sentiment was a better predictor of monthly stock performance than Sell-side Earnings Revisions for large cap stocks.

Source: Empirical Research Partners, "Stock Selection: Research and Results", August 2018

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