What Drives Firm-level Consensus Growth Forecasts? Cash Flow News Or Expected Return News?

Recent findings in the finance literature document that analysts adjust their growth forecasts in response to major news, proxied by large changes in company stock price. However, Campbell and Shiller (1988) argue that stock prices, themselves, carry two sets of information: news about changes in cash-flow expectation (i.e. cash flow news) and changes in discount rate (i.e. expected return news). The former one directly relates to changes in expectation about the fundamentals of the company while the latter one to the changes in market expectation. Hence, are analysts more concerned about expectation of the permanent movement in the stock price (cash flow news) or the temporary movement in the stock price (expected return news)? In this study, I use a firm-level vector autoregressive approach to examine the relative impact of cash flow news and expected return news on unexpected changes in analysts next fiscal year growth forecasts. My findings indicate that analysts do raise their forecasts on positive cash flow news. However, the magnitude of the response to cash flow news is significantly lower than the magnitude of the response to expected return news. This suggests that while analysts do react to changes in firm fundamentals, they respond more strongly to changes in future expected return.