The full setting: Analysts' predictive ability - the truth is in the continual coverage

The literature that surrounds the predictive ability of equity analysts has, to date, presented conflicting results. The censoring of analysts’ true expectations, through their documented selective coverage of firms, has led to suggestions that the empirical results surrounding analysts’ predictive ability are systematically biased. This study circumvents the inherent bias evident in published forecasts and opinions by utilising the true expectations that analysts’ selective coverage necessarily reveals. These underlying expectations are captured by obtaining residual analyst continual coverage from a model of analyst following. While prior empirical research has utilised this methodology to explore analysts’ predictive ability, it has done so in limited settings. This study extends the predictive ability literature by providing evidence in an unrestricted setting, where analyst coverage is ongoing and continual. At the same time, whether the selective coverage of firms by analysts is a continual process or restricted to situations where explicit coverage decisions are made is evaluated. The empirical results suggest that the returns in the three subsequent years following a measure of residual analyst coverage are significantly better for firms with high residual coverage than firms with low residual coverage. That is, residual analyst continual coverage is positively related with subsequent firm performance. This evidence indicates that analysts possess predictive ability and selectively provide coverage for firms and update their coverage frequently in line with their changing expectations.