We wiil attempt to remedy this deficiency shortly, in Table 5. For the moment, it suffices to say that the imperfect size matching in Table 4 does not color any of the conclusions.
Turning to the returns numbers, two patterns emerge that hold up throughout our subsequent analysis. First, as predicted by the theory, there is more momentum in stocks with low residual coverage. The P3-P1 momentum measure is 1.13% per month in the low-residual-coverage subsample SUB1, and only 0.72% per month in the high-residual-coverage subsample SUB3. The difference of 0.42% between SUB1 and SUB3 in this regard is highly statistically significant, with a t-stat of 3.50. Moreover, the economic magnitude is clearly important–momentum profits are roughly 60% higher in SUB1 than in SUB3.
The second key finding is that the effect of residual coverage on the P3-P1 momentum measure is entirely driven by what happens in the loser stocks in PI. P1/SUB1 stocks underperform P1/SUB3 stocks by 0.70% per month. This difference is also highly significant, with a t-stat of 5.16. In other words, one attractive strategy, which we call the “loser-analyst-spread trade”, or “LAST” strategy, is simply to buy the stocks in P1/SUB3 and short those in P1/SUB1, without ever dealing with any of the winner stocks in P3. This strategy is not only size-neutral, it is also (unlike the Jegadeesh-Titman strategy) momentum-neutral. So to the extent that anybody ever makes an argument that momentum returns are proxying for a risk factor, our LAST strategy earns 0.70% per month with no loading on that risk factor.
Taken together, these two patterns suggest that analyst coverage is especially important in propagating bad news. This ties together nicely with our earlier finding that the bulk of momentum profits seem to come from loser stocks. And as we noted in the Introduction, it also makes intuitive economic sense. When firms are sitting on good news, managers probably have every incentive to push this news out to investors as fast as possible, which makes analysts less important. In contrast, when there is bad news, managers are likely to be less forthcoming, so outside analysts have a more crucial role to play.