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They range from 1.0 and 0.7 basis points for strong buys and buys, respectively, to -2.5 and -2.4 basis points for sells and strong sells, respectively.
Within each momentum quintile, we again find that the average daily abnormal return for buys and strong buys is reliably greater than that for sells and strong sells (with the difference ranging between 2.0 and 3.9 basis points), indicating that recommendation levels have explanatory value for future returns, even conditional on price and earnings momentum.
The corresponding returns for sells and strong sells are a significant -2.5 and -2.4 basis points, respectively.
Also, downgrades to buy should outperform downgrades to hold, sell, and strong sell. Note again that our unconditional return results cannot be used to address this issue as it is possible that the higher average returns to buys and strong buys are due to these recommendations predominantly being upgrades, while the lower average returns to holds, sells, and strong sells are due to these recommendations predominantly being downgrades.
Similarly, a strategy of shorting all single downgrades to sell or strong sell significantly outperforms a strategy of either shorting all single downgrades or shorting all sells and strong sells.
Conditioning on downgrades of one ratings level (sometimes referred to as single downgrades), the stocks rated sell or strong sell generate a significantly negative average daily abnormal return of -3.4 basis points, while those rated buy are associated with an insignificant average daily abnormal return of -0.5 basis points.
This potential for improved returns is illustrated in Figure 1, which plots the cumulative daily raw returns to 1) a levels-only hedge strategy of purchasing all stocks rated buy or strong buy and selling short all stocks rated sell or strong sell, 2) a changes-only hedge strategy of purchasing all upgraded stocks and shorting all downgraded ones, and 3) a levels- and changes-based hedge strategy of purchasing all stocks receiving a double upgrade to buy or strong buy and shorting all those receiving a double downgrade to sell or strong sell.
At its core, a buy or strong buy means that an analyst expects the stock price to increase (sometimes by a certain minimum amount), either on an absolute or relative basis over a specified time (usually the next 12 to 18 months); a sell or strong sell means that the expected stock return is negative; and a hold means that the expected return is close to zero.
Both databases code recommendations using a five-point scale, ranging from 1 for strong buy to 5 for strong sell. While the databases employ a five-point scale, some brokers choose to issue only three different ratings--the equivalent of buy, hold, and sell--while still others switch between a five-point and a three-point scale during our sample period.
Of the more than 1,000,000 recommendations in our sample, only 9.8%, or about 97,000, are movements to, or initiations of, either sell or strong sell. The dearth of such recommendations has been well documented in the literature and is consistent with analysts' alleged reluctance to issue negative recommendations on the firms they follow.
For all recommendations with the same MI score, we construct a portfolio of buy- and strong-buy-rated stocks and another of those rated sell or strong sell. Separately, we form a portfolio of stocks receiving upgrades and another of those receiving downgrades.
Strong sells to the auto industry and a wide variety of other industries through four warehouse/offices in Ohio, two in Indiana, and one in Pennsylvania.
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