Analyzing Financial Analysts: What They Look for in Financial Reports and How They Determine Earnings' Quality

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Analyzing Financial Analysts: What They Look for in Financial Reports and How They Determine Earnings' Quality Carol M Graham, Mark V Cannice, Todd L Sayre. Journal of Management Research. New Delhi: Aug 2002. Vol. 2, Iss. 2; pg. 63, 10 pgs Abstract (Summary)

The impact that financial analysts have on the share prices of publicly held companies has come under increasing scrutiny. However, despite the role they play in the financial markets, surprisingly little is known about the way in which analysts evaluate companies', report financial information or how they assess the quality of companies' earnings. We surveyed 34 financial analysts across 18 industries to address two issues in tandem - their use of financial information and their determination of earnings' quality. We found that analysts rely primarily on adjusted earnings figures, line of business data, reported cash flows, and the use of accounting conservatism in evaluating companies. Further, analysts regarded earnings growth, corporate growth prospects, risk, and recurring earnings as the primary determinants of quality for a company's earnings. Given these findings, it seems prudent for managers to focus corporate strategy on improving the results that are most closely inspected - i.e. earnings growth, growth prospects, reduction of financial and operating risk, and the persistence of earnings. [PUBLICATION ABSTRACT]

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Copyright South Asia Publications Aug 2002

[Headnote]
Abstract
The impact that financial analysts have on the share prices of publicly held companies has come under increasing scrutiny. However, despite the role they play in the financial markets, surprisingly little is known about the way in which analysts evaluate companies', report financial information or how they assess the quality of companies' earnings. We surveyed 34 financial analysts across 18 industries to address two issues in tandem - their use of financial information and their determination of earnings' quality. We found that analysts rely primarily on adjusted earnings figures, line of business data, reported cash flows, and the use of accounting conservatism in evaluating companies. Further, analysts regarded earnings growth, corporate growth prospects, risk, and recurring earnings as the primary determinants of quality for a company's earnings. Given these findings, it seems prudent for managers to focus corporate strategy on improving the results that are most closely inspected - i.e. earnings growth, growth prospects, reduction of financial and operating risk, and the persistence of earnings. Keywords: Financial Analysts, Financial Reports, Earnings' Quality

Introduction

The impact that financial analysts have on the share prices of publicly held companies has come under increasing scrutiny. Questions of analysts' independence from the investment banking and brokerage units of the Wall Street firms they work for continue to be raised. The bursting of the Internet bubble and resulting NASDAQ crash have led to finger pointing at certain analysts who, some feel, may have contributed to the market mania that preceded the crash. Further, the recent implementation of Regulation Full Disclosure (Reg. FD), the SEC's mandate that limits managers' private communications with analysts, compounds the problem by complicating analysts' earnings forecasts. Still, executives of publicly held firms continue to be accountable to financial analysts whose ability to widely project their opinions on firms' financial results has grown with the rise in business news in TV and radio. However, despite the role they play in the financial markets, surprisingly little is known about the way in which analysts evaluate companies' reported financial information or how they assess the quality of their earnings.

Executives would be better able to respond to analysts' concerns if they had a clearer insight into which...
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