Wednesday, July 06, 2011

Regarding Analysts' Estimates

As earnings season for US equities begins this quarter, it's worthwhile to take note of a recent Wall Street Journal column by Jason Zweig concerning analysts' earnings estimates.

Consider this gem,

"On average, according to Denys Glushkov, research director at WRDS, stock analysts are revising their earnings forecasts nearly twice as frequently as they did a decade ago. And while the typical forecast missed the mark by 1% in the 1990s, that margin of error has lately been running at triple that rate."

Which is sort of shocking, since I recall back in 1997, my business partner at the time noted how analysts' earnings estimate errors had risen significantly from prior years. Even then, analysts' estimates had become somewhat of a joke.

Now, a decade and a half later, they've deteriorated even more.

Zweig goes on to describe a process by which companies actively guide estimates and play games in order to make sure that their actual earnings announcement is a bona fide "surprise."

Again, from Zweig,

"In the first quarter of 2011, according to Bianco Research, 68% of the companies in the S&P500 earned more than the consensus, or median, forecast by analysts. What's more, that quarter was the ninth in a row when at least two-thirds of the companies in the S&P generated positive surprises- and the 50th consecutive quarter in which at least half of the companies surpassed the consensus forecast of their earnings."

My equity portfolio selection process has never used anything but historic information. However, I recall, back in 1998, that the hedge fund with which I was collaborating was investigating another person's work claiming to add value to equity selections by analyzing earnings estimates. Apparently it looked very promising. But after a few months of scrutiny and testing, whatever alleged value in the method was found to be non-existent.

Still, the process employs a lot of people at sell-side brokerages and buy-side funds. So I guess, despite its relative lack of usefulness, the process of estimating corporate earnings adds value by keeping some people on payrolls in the financial services industry.

Meanwhile, you might think about this topic and post in the next few weeks, as all those earnings "surprises" roll in among S&P500 companies.

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