Analysts coming from the industry they now cover are 3.6% more accurate in their earnings forecasts, write Daniel Bradley, Sinan Gokkaya and Xi Li

Bradley, Daniel

Gokkaya, Sinan

Liu, Xi

LSE Research Online

Thinking	of	becoming	an	equity	analyst?	Getrelevant	industry	experience	firstSell-side	equity	analysts	provide	research	coverage	on	a	portfolio	of	firms	(typically	between	10	and	15)	anddisseminate	their	research	in	the	form	of	earnings	forecasts	and	stock	recommendations	to	clients	to	help	themmake	investment	decisions.	The	importance	of	industry	expertise	is	often	cited	among	practitioners	as	the	mostimportant	characteristic	an	analyst	can	possess	and	consistent	with	the	observation	that	most	analysts’	coverageportfolios	are	concentrated	in	one	or	few	industries.For	instance,	each	year	Institutional	Investor	ranks	the	top	analysts	in	each	industry	based	on	survey	results	bybuy-side	institutions	that	use	their	services.	In	addition	to	analyst	ranks,	they	also	ask	respondents	to	indicate	themost	important	trait	they	seek	in	an	analyst.	For	over	a	decade,	industry	expertise	has	been	rated	the	numberone	aspect	in	every	single	year.But	how	does	one	measure	analysts’	industry	expertise?	One	obvious	way	(and	one	we	control	for)	is	to	examinethe	amount	of	time	an	analyst	has	provided	earnings	forecasts	and	recommendations	on	firms	in	a	particularindustry.	While	seemingly	intuitive,	this	measure	would	be	highly	correlated	with	the	amount	of	analyst-	and	firm-specific	forecasting	experience	an	individual	analyst	will	have.	Instead,	we	take	a	different	approach	and	considerwhether	or	not	an	analyst	worked	before	they	became	an	analyst.	To	determine	an	analysts’	work	history,	wemanually	collect	analysts’	entire	employment	backgrounds	from	LinkedIn.Consider	a	hypothetical	example	to	illustrate	our	statistical	approach.	Before	becoming	an	analyst,	John	Doeused	to	work	at	Walmart	before	taking	an	equity	analyst	position	at	Goldman	Sachs.	John’s	coverage	portfolioconsists	of	12	firms,	of	which	8	are	in	the	retail	industry	and	4	are	in	the	media	industry.	Thus,	John	has	relevantindustry	experience	with	respect	to	the	8	firms	in	the	retail	sector,	but	does	not	have	industry	expertise	for	the	4firms	he	covers	in	media.	Does	this	industry	experience	help	make	John	a	better	analyst?	Our	statistical	testscompare	analysts	with	no	prior	industry	experience	(i.e,	they	went	to	work	immediately	as	an	analyst	followingcollege)	to	those	with	related	industry	experience	(i.e.,	John’s	coverage	portfolio	of	retail	companies)	and	thosewith	unrelated	industry	experience	(i.e.,	John’s	coverage	portfolio	of	media	companies).LSE Business Review: Thinking of becoming an equity analyst? Get relevant industry experience first Page 1 of 3		Date originally posted: 2017-07-24Permalink: http://blogs.lse.ac.uk/businessreview/2017/07/24/thinking-of-becoming-an-equity-analyst-get-relevant-industry-experience-first/Blog homepage: http://blogs.lse.ac.uk/businessreview/Our	evidence	clearly	supports	the	notion	that	prior	industry	experience	aids	analysts’	performance.	Usingregression	analysis	in	a	sample	of	over	100,000	earnings	forecast	revisions	made	by	analysts	over	the	1983	to2011	time	period,	we	estimate	that	earnings	forecasts	of	industry-experienced	analysts	are	3.6	per	cent	moreaccurate	compared	to	other	analysts.	Market	reactions	to	earnings	revisions	by	analysts	with	similar	industryexperience	to	their	coverage	firms	are	also	more	impactful.	For	instance,	upward	(downward)	earnings	revisionsby	analysts	with	industry	experience	are	associated	with	market	responses	that	are	approximately	0.4	per	cent	(-0.5	per	cent)	greater.In	addition	to	their	earnings	forecasts,	we	also	examine	the	performance	of	stock	recommendations.	Consistentwith	superior	earnings	forecasts,	following	the	recommendations	of	analysts	with	industry	relevant	experience	canbe	profitable.	For	example,	we	find	that	the	stock	recommendations	of	industry	experienced	analysts	performapproximately	4	per	cent	better	per	year	compared	to	inexperienced	industry	analystsSince	industry	expertise	helps	analysts	perform	their	job	better,	we	analyse	whether	it	helps	advance	theircareers.	Ideally,	we	would	be	able	to	tie	job	performance	to	salaries,	but	data	constraints	prohibit	us	from	doingso.	Instead,	we	proxy	for	analysts’	career	concerns	using	Institutional	Investor’s	(II)	annual	all-star	poll.	Analystsstrive	to	make	this	list	because	compensation	is	heavily	tied	to	it.	For	instance,	an	academic	study	suggests	thatanalysts	that	are	rated	as	II	all-stars	enjoy	more	than	a	50	per	cent	salary	premium	to	non-stars.	We	find	thatanalysts	with	previous	industry	experience	are	43	per	cent	more	likely	to	attain	this	stature.Finally,	we	examine	the	real	economic	consequences	of	industry	experienced	analyst	coverage	on	firms.	Analystcoverage	is	sought	by	firms	to	improve	their	information	environment,	and,	consequently	stock	price.	When	a	firmloses	analyst	coverage,	this	information	environment	deteriorates	and	results	in	lower	liquidity	and	price	declines.We	examine	the	negative	impact	of	such	losses	of	analyst	coverage	for	firms	that	are	covered	by	analysts	withindustry	expertise	to	those	that	do	not	possess	relevant	industry	experience.	Losing	analysts	with	industryexpertise	has	a	much	greater	negative	impact	on	the	firm	than	losing	non-industry	analyst	experts.♣♣♣Notes:This	blog	post	is	based	on	the	authors’	paper	Before	an	Analyst	Becomes	an	Analyst:	Does	IndustryExperience	Matter?,	Journal	of	Finance,	April	2017.	The	post	gives	the	views	of	its	authors,	not	the	position	of	LSE	Business	Review	or	the	London	School	ofEconomics.Featured	image	credit:	Stock	exchange,	by	geralt,	under	a	CC0	licence	When	you	leave	a	comment,	you’re	agreeing	to	our	Comment	Policy.Daniel	Bradley	is	a	Professor	of	Finance	at	the	Muma	College	of	Business,	University	of	SouthFlorida,	and	holds	the	Lykes	Chair	in	Finance	and	Sustainability.	His	research	broadly	focuses	oncorporate	finance	and	investments	with	a	particular	focus	on	securities	issuance	and	analystbehaviour.	He	has	published	in	most	of	the	premier	journals	in	the	field	and	his	work	has	beencited	in	the	Wall	Street	Journal,	USA	Today,	and	other	media	outlets.	He	currently	serves	as	anassociate	editor	for	the	Journal	of	Financial	Research.	He	holds	a	PhD	from	the	University	ofKentucky	and		was	granted	the	CFA	designation	in	1998.Sinan	Gokkaya	is	an	Assistant	Professor	of	Finance	and	Robert	H	Freeman	Fellow	at	OhioUniversity.	He	holds	a	Ph.D.	in	Finance	with	a	minor	in	Economics.	He	is	actively	involved	ininvestment	and	wealth	management	products.	His	practitioner-oriented	research	focuses	on	sell-side	and	buy-side	equity	analysts,	asset	management	and	investment	banking	as	well	as	corporatefinance	and	governance	of	public	firms.	He	has	received	the	University	of	Pennsylvania’s	WhartonSchool-WRDS	Outstanding	Paper	in	Empirical	Research	in	2014,	and	a	number	of	other	awards.	His	papers	have	been	published	in	leading	academic	journals.LSE Business Review: Thinking of becoming an equity analyst? Get relevant industry experience first Page 2 of 3		Date originally posted: 2017-07-24Permalink: http://blogs.lse.ac.uk/businessreview/2017/07/24/thinking-of-becoming-an-equity-analyst-get-relevant-industry-experience-first/Blog homepage: http://blogs.lse.ac.uk/businessreview/Xi	Liu	is	an	assistant	professor	at	Miami	University	in	Ohio.	He	received	his	PhD	in	Finance	fromthe	University	of	South	Florida	in	2012.	His	research	interests	include	sell-side	equity	analysts	andinsider	trading.	Dr	Liu	received	was	awarded	the	Wharton	School-WRDS	Outstanding	Paper	inEmpirical	Research,	EFA,	2014.		LSE Business Review: Thinking of becoming an equity analyst? Get relevant industry experience first Page 3 of 3		Date originally posted: 2017-07-24Permalink: http://blogs.lse.ac.uk/businessreview/2017/07/24/thinking-of-becoming-an-equity-analyst-get-relevant-industry-experience-first/Blog homepage: http://blogs.lse.ac.uk/businessreview/

Thinking of becoming an equity analyst? Get relevant industry experience first

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