Significance Of Analyst Projections*
On Wall Street great emphasis is placed on research carried out by analysts.
Though their estimates usually aren’t worth the paper they are written on, they are closely gauged by Street professionals. If the business misses their estimates by more than 5% the stock gets hammered, unless it is already of the out-of-favor, low-P/E, low-valuation group. If the company exceeds analysts’ estimates by greater than 5% the stock will soar, unless it is was highly favored before the fact with future prospects largely discounted into the price.
Analysts’ earnings estimates and growth projections usually exceed actuality because of several major (limiting) factors:
1. Analysts are, on the whole, overconfident in their abilities to predict future outcomes.
2. Analyst are, on the whole, overly optimistic about the industries they research.
3. There tends to be great external, implied, pressure on analysts from companies they research to be so optimistic because it is in the favor of the company (being ‘researched’) that investors continually buy their stock.
4. If the analyst goes the other way buy issuing (truthful) negative recommendations about a business, his/her firm (investment bank/brokerage house) will usually get the cold shoulder from the company and be excluded from future lucrative deals – i.e., issuance of more stock, spinning-off of a division, issuance of corporate bonds, etc… As a result the investment bank will fire the analyst for “other reasons”. So, fearful of such a blow to their careers, analysts tend to “go with the flow” and do what is “appropriate” with respect to their employers even though it may be morally inappropriate. And there is “good” reason for doing so in the analyst’s own opinion – personal benefit. In other words, the perks of being an analyst for a major brokerage house are so seductive – the pay, media limelight, the admiration and even envy of peers – that few would chose to opt for putting it all on the line over a “insignificant” recommendation on their part. And so the analyst continues to do best what they’re actually paid to do – be a master salesperson for their firm.
5. Analysts are bombarded by too much information, 90% of which they have difficulty applying to their projections. The “information age” has, thus, made the analyst’s jobs even tougher because there are only so many variable one can focus upon without distorting the actual prospects of a business. Nowadays, analysts are required to keep in touch with as many as 50+ media sources their firms subscribe to for every stock they are researching, and to do this on a daily basis.
6. Many analysts have difficulty garnering information crucial to their projections from the company (being researched) directly due to the “code of silence” required of such organizations by governing bodies as the SEC, NYSE, NASDAQ, AMEX, other stock exchanges, and the law. And the top management of most businesses tend to become irritated by estimate related inquires by analysts that analysts tend to “accept” whatever bits and pieces of information management throws them without knowing its validity until the event actually plays itself out.
7. Analysts, like “ordinary people”, are prone to error in judgment. Just as the fund and institutional managers are notorious for getting in and out of investments at the wrong places, analysts too make such mistakes with respect to their research and recommendations. For example, an analyst might, legitimately, project a growth rate which is later is found to be too high.
8. Point 4 above says that analysts are under pressure from their own firms to issue “strong buys” and make forecast superior growth for the company being researched because of future interests of their brokerage house/investment bank. However, there may also be pressure on the analyst to do such things because of present interests of their respective firms. It doesn’t make a whole lot of sense to recommend a “strong sell” and project poor future earnings growth on a business (even if is true) if your investment bank (boss) owns 10% of it to which a large percentage of your retirement pay and stock options are tied. In other words, analysts themselves may be crooked (for self benefit).
9. The “consensus” of analyst estimates (of everything) regarding an enterprise are deemed more accurate future predictors by the Street than predictions of a single analyst among the group. In other words, the most accurate analyst’s estimate may be skewed up or down because it is averaged with estimates from other analysts.
10. Investment banks place great emphasis on their analysts to make the “all star research team”. This is the classification given by Institutional Investor magazine to analysts who’s estimates are closest to real results for the year. Investment banks and brokerages houses want “all star” analysts performing for them because it can deliver greater profitability to the firm. Such profitability is the result of bank trust departments, mutual funds, and institutional investors wanted to do business with (generate transaction fees and commissions for) the broker/investment bank who can provide the “best of the best” analysis on investments. For example, if a Merrill Lynch analyst makes the No. 1 spot in the “Institutional Investor All Star Research Team” for the year, a mutual fund manager would want to keep the analyst at an arms length for consultation and to do so makes sense if the fund can provide something of return, like a verbal agreement to do business with Merrill Lynch as a way of saying, “thanks”. It then becomes the obligation of the analyst to keep the fund well-informed while also appeasing his firm’s other clients (the company being researched) in efforts to meet their personal bottom lines – higher salaries, more stock options, greater media exposure, the envy and admiration of their peers, and most importantly, a pleased boss. Therefore, an analyst cannot provide accurate projections of a company because he/she is, in a way, a “slave” to several masters.
Though their estimates usually aren’t worth the paper they are written on, they are closely gauged by Street professionals. If the business misses their estimates by more than 5% the stock gets hammered, unless it is already of the out-of-favor, low-P/E, low-valuation group. If the company exceeds analysts’ estimates by greater than 5% the stock will soar, unless it is was highly favored before the fact with future prospects largely discounted into the price.
Analysts’ earnings estimates and growth projections usually exceed actuality because of several major (limiting) factors:
1. Analysts are, on the whole, overconfident in their abilities to predict future outcomes.
2. Analyst are, on the whole, overly optimistic about the industries they research.
3. There tends to be great external, implied, pressure on analysts from companies they research to be so optimistic because it is in the favor of the company (being ‘researched’) that investors continually buy their stock.
4. If the analyst goes the other way buy issuing (truthful) negative recommendations about a business, his/her firm (investment bank/brokerage house) will usually get the cold shoulder from the company and be excluded from future lucrative deals – i.e., issuance of more stock, spinning-off of a division, issuance of corporate bonds, etc… As a result the investment bank will fire the analyst for “other reasons”. So, fearful of such a blow to their careers, analysts tend to “go with the flow” and do what is “appropriate” with respect to their employers even though it may be morally inappropriate. And there is “good” reason for doing so in the analyst’s own opinion – personal benefit. In other words, the perks of being an analyst for a major brokerage house are so seductive – the pay, media limelight, the admiration and even envy of peers – that few would chose to opt for putting it all on the line over a “insignificant” recommendation on their part. And so the analyst continues to do best what they’re actually paid to do – be a master salesperson for their firm.
5. Analysts are bombarded by too much information, 90% of which they have difficulty applying to their projections. The “information age” has, thus, made the analyst’s jobs even tougher because there are only so many variable one can focus upon without distorting the actual prospects of a business. Nowadays, analysts are required to keep in touch with as many as 50+ media sources their firms subscribe to for every stock they are researching, and to do this on a daily basis.
6. Many analysts have difficulty garnering information crucial to their projections from the company (being researched) directly due to the “code of silence” required of such organizations by governing bodies as the SEC, NYSE, NASDAQ, AMEX, other stock exchanges, and the law. And the top management of most businesses tend to become irritated by estimate related inquires by analysts that analysts tend to “accept” whatever bits and pieces of information management throws them without knowing its validity until the event actually plays itself out.
7. Analysts, like “ordinary people”, are prone to error in judgment. Just as the fund and institutional managers are notorious for getting in and out of investments at the wrong places, analysts too make such mistakes with respect to their research and recommendations. For example, an analyst might, legitimately, project a growth rate which is later is found to be too high.
8. Point 4 above says that analysts are under pressure from their own firms to issue “strong buys” and make forecast superior growth for the company being researched because of future interests of their brokerage house/investment bank. However, there may also be pressure on the analyst to do such things because of present interests of their respective firms. It doesn’t make a whole lot of sense to recommend a “strong sell” and project poor future earnings growth on a business (even if is true) if your investment bank (boss) owns 10% of it to which a large percentage of your retirement pay and stock options are tied. In other words, analysts themselves may be crooked (for self benefit).
9. The “consensus” of analyst estimates (of everything) regarding an enterprise are deemed more accurate future predictors by the Street than predictions of a single analyst among the group. In other words, the most accurate analyst’s estimate may be skewed up or down because it is averaged with estimates from other analysts.
10. Investment banks place great emphasis on their analysts to make the “all star research team”. This is the classification given by Institutional Investor magazine to analysts who’s estimates are closest to real results for the year. Investment banks and brokerages houses want “all star” analysts performing for them because it can deliver greater profitability to the firm. Such profitability is the result of bank trust departments, mutual funds, and institutional investors wanted to do business with (generate transaction fees and commissions for) the broker/investment bank who can provide the “best of the best” analysis on investments. For example, if a Merrill Lynch analyst makes the No. 1 spot in the “Institutional Investor All Star Research Team” for the year, a mutual fund manager would want to keep the analyst at an arms length for consultation and to do so makes sense if the fund can provide something of return, like a verbal agreement to do business with Merrill Lynch as a way of saying, “thanks”. It then becomes the obligation of the analyst to keep the fund well-informed while also appeasing his firm’s other clients (the company being researched) in efforts to meet their personal bottom lines – higher salaries, more stock options, greater media exposure, the envy and admiration of their peers, and most importantly, a pleased boss. Therefore, an analyst cannot provide accurate projections of a company because he/she is, in a way, a “slave” to several masters.
*David Dreman, "Contrarian Investment Strategies in the Next Generation"
posted by Raphael Blogger at
11:04 PM
