Abstract
When an analyst changes his recommendation of a stock, his valuation differs from the market’s`valuation based on differences in earnings estimates and/or discount rate estimates. We argue that earnings-based recommendation changes are characterized by harder information, greater verifiability, and shorter forecast horizons than discount rate-based recommendation changes.Therefore, earnings-based recommendation changes are less subject to analysts’ cognitive and incentive biases and thus they have greater investment value than discount rate-based recommendation changes. Consistent with this argument, we find that investors differentiate between earnings-based and discount rate-based recommendation changes. Both the initial market reaction to and the drift after recommendation changes are twice as big for earnings based versus discount rate-based recommendation changes. Trading on earnings-based recommendation changes earns risk-adjusted returns of over three percent per month.