Wall Street analysts still hyping their stock picks

Wall Street analysts are painting an awfully rosy picture of earnings growth, according to a study done by Penn State researchers. “[T]heir long-term earnings-per-share growth-rate forecasts are excessive and upwardly biased,” says J. Randall Woolridge, a professor of finance at the Smeal College of Business.

Over the period 1984 to 2006, analysts’ predicted EPS growth at an average of 14.7% for the long term (three to five years). Actual EPS growth: 9.1%.

On one-year forecasts, analyst projections fared a little better, but they were still overly optimistic: 13.8% instead of the actual rate of 9.8%.

So why is this happening?

  • Analysts’ employers want them to hype stocks so the brokerage can win commissions and underwriting deals. “This conflict of interest should have been squelched by former New York Attorney General Elliot Spitzer’s investigation and the $1.5 billion payment made by U.S. investment firms in the 2003 Global Analysts Research Settlements (GARS).” But the study found that GARS had no effect; analyst forecasts remained at their historic levels of about 15%.
  • Analysts don’t issue forecasts on stocks they don’t like.
  • Analysts becoming attached to the companies that they follow and, as a result, lose objectivity.

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Related:
Most companies fail at forecasting earnings
The fallacy — and cost — of giving quarterly earnings guidance

Most companies fail at forecasting earnings

Two out of every three companies are unable to accurately forecast earnings for the next quarter, missing the mark by anywhere from 6% to over 30%, according to a study of 70 multinational companies by The Hackett Group.

We’ve all seen cases where missed earnings projections led to sharp stock declines, CFO firings, or worse. But often companies don’t take the steps necessary to get better at forecasting, Hackett analysts say.

Continue reading “Most companies fail at forecasting earnings”

Futurists need to be historians, too

“Look back twice as far as you look forward,” writes forecaster Paul Saffo in his Harvard Business Review article “Six Rules for Effective Forecasting” (July-August 2007). It would be easy to misunderstand that powerful statement — Saffo’s Rule No. 5 — so let’s dissect it a bit.

Notice that he says “look back twice as far.” Recent history rarely repeats itself directly. Futurists can make big mistakes extrapolating from recent history, Saffo says, so you need to look much farther back to identify useful patterns. For example, the Web’s dramatic transformation of the media landscape seems to defy categorization, unless you look back 50 years to the emergence of television. Saffo writes:

The texture of past events can be used to connect the dots of present indicators and thus reliably map the future’s trajectory — provided one looks back far enough.

He adds that, although you may find useful patterns in the past, don’t try to force exact matches.

It’s been written that “history doesn’t repeat itself, but sometimes it rhymes.” The effective forecaster looks to history to find the rhymes, not the identical events.

Two other interesting Saffo Rules (paraphrased by me):

  • Good forecasting is the process of having strong opinions that are held weakly. Always look for conflicting evidence so you can ditch a bad prediction.
  • Know when not to make a forecast. Sometimes there are “moments of unprecedented uncertainty,” when it’s better to let things settle down before even attempting a prediction.

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Related:
How to Forecast the Future, a Q&A interview with Paul Saffo