NEWS

Researchers at Ohio State (Michael S. Drake) and Texas A&M Universities (Lynn L. Rees and Edward P. Swanson) examined the value of short sellers in guiding investment decisions ( “Should Investors Follow the Prophets or the Bears? Evidence on the Use of Public Information by Analysts and Short Sellers” ). They find:

“First, we find that analysts and short sellers use publicly available information differently. Analysts over-recommend stocks with high growth, high accruals, and low book-to-market ratios, even though prior research shows these characteristics are negatively related to future returns. In contrast, short sellers incorporate into their investment decisions the future return implications of all eleven accounting and market variables considered in this study.

“Second, we find that short interest provides information about future returns beyond that provided in the eleven items of information that prior research shows to be predictive of future returns. Analysts’ recommendations also provide incremental information, but a negative coefficient suggests trading against the analysts.

“Third, based on these results, we show that a highly profitable trading strategy is one where investors trade with the short sellers when the short interest signal strongly conflicts with the consensus analyst recommendation. In fact, the value of short interest in choosing stocks to buy or sell is greater when conditioned on a conflicting consensus recommendation than when used by itself to trade stocks.

“An important implication of our study is that regulations that restrict or increase the cost of short selling run the risk of limiting a potentially important source of information for investors about future equity values.”