Investment firms and brokerage houses are increasingly using ‘top picks’ to supplement stock recommendations (Chart 1). These ‘highest-conviction best ideas’ are typically announced December-February and garner significantly more media attention.
An NBER paper examines these top picks’ stock performance and whether analysts use them to inflate the value of their clients’ stock prices. They find the following:
Top picks generate greater excess returns than traditional buy recommendations (17% annualised excess returns (1.33% monthly), compared with 6.5% for buy recommendations).
They are characterised by higher expected EPS and stock return performance, tend to be issued by relatively larger firms, are more likely to be growth and momentum stocks, and are more visible to the investment community. Further, their selection is negatively associated with uncertainty and risk.
Bad top picks are more likely to be ‘strategic selections’. That is, they are more likely to be affiliated with the investment banking arm of the analyst’s brokerage house. However, the analysts recommending these bad top picks are generally penalised by demotions.
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