Asset Growth and Analysts’ Multi-Period Earnings Forecasts

Using analysts’ multi-period earnings forecasts, we examine whether analyst forecast bias is related to asset growth. We find that analyst forecasts are more optimistic for firms with higher asset growth. This relation is particularly noticeable for longer-term (e.g., two- and three-year-ahead) forecasts than for shorter-term (e.g., one-year-ahead) forecasts. Moreover, analyst optimism for high-growth firms is greater for 1) firms that have maintained similar levels of growth over recent periods, 2) firms with higher information uncertainty, and 3) forecasts with longer forecast horizons (e.g., forecasts issued far before the fiscal year-end). We examine to what extent analyst optimism for high-growth firms explains the asset growth effect (i.e., a negative association between asset growth and subsequent stock returns). Controlling for forecast bias in a growth-return regression substantially attenuates the asset growth effect, suggesting that forecast bias plays an important role in the asset growth effect. Path analysis further suggests that analysts’ long-term (but not short-term) forecast bias is an important mediator through which biased expectations about asset growth are incorporated into stock prices. Overall, our findings are consistent with the extrapolation bias explanation for the asset growth effect.