Analysts' qualitative statements and the profitability of favorable investment recommendations

In this study, we examine the relation between sell-side analysts' justifications and favorable rating profitability. Using a novel text analysis methodology, we transform analysts' qualitative statements into a content-based text signal. Our results indicate that information contained in analysts' justifications is indeed associated with favorable recommendation profitability, controlling for information in the quantitative summary measures. We also develop trading strategies using our text signal and find that using the text signal generates economically significant returns. Importantly, to increase our understanding of factors associated with favorable rating quality, we disaggregate the text signal into five discrete information categories. Results show that references to historical financial and nonfinancial performance measures contain significant predictive power. Our findings have important implications for investors and financial analysts.