Analysts' coverage of a company at its initial public offering exhibits a positive and significant correlation with subsequent stock returns, a recent study published in the June issue of the Journal of Finance shows. The authors compiled the number of analysts' initiating coverage on companies going public for the years 1986-2000 and followed the companies' performance for three years thereafter. The authors' findings showed that more analysts' covering a company amounts to an annualized buy-and-hold return of 8.71% over portfolios matched by size and book-to-market ratio and a 7.71% return in excess of portfolios matched by industry.

"These results suggest that the initial decision by analysts to provide coverage for a firm around the first public issuance is predictive of stock returns and operating performance in the following three years," the authors, Somnath Das, Re-Jin Guo and Huai Shang, wrote.

Previous authors used published forecasts and stock recommendations to derive analysts' predictive ability. The authors of this study, however, bypassed published reports and chose instead to look at the analysts' decision to initiate coverage on a company. "In a market catering to investors and corporate clients alike, selective coverage results from economic disincentives for analysts to reveal unfavorable opinions." This [study] suggests that investors can draw valuable inferences from analysts' decision to selectively follow certain companies, the authors conclude.