A recently updated study conducted by McKinsey&Company reveals that equity analysts are often too optimistic in their earnings forecasts and almost always lag behind changing economic conditions. Even worse, when economic conditions deteriorated, analysts were prone to making increasingly inaccurate predictions.
Despite a series of rules and regulations enacted 10 years ago to, among other things, restore investor confidence in earnings forecasts, nothing has changed. The U.S. Securities and Exchange Commission (SEC) Regulation Fair Disclosure (FD), passed in 2000, prohibits the selective disclosure of material information to some people but not others. The Sarbanes–Oxley Act of 2002 includes provisions specifically intended to help restore investor confidence in the reporting of securities’ analysts, including a code of conduct for them and a requirement to disclose knowable conflicts of interest. The Global Settlement of 2003 between regulators and ten of the largest US investment firms aimed to prevent conflicts of interest between their analyst and investment businesses.
McKinsey concludes that none of these regulatory changes has resulted in any improvement in earnings forecasts. “For executives, many of whom go to great lengths to satisfy Wall Street’s expectations in their financial reporting and long-term strategic moves, this is a cautionary tale worth remembering.”
Interestingly, the only occasions where earnings generally matched forecasts was in periods of strong economic growth. In other words, only when the economy surged did it meet the overly optimistic forecasts of equity analysts.
The take-away here for investors is that we must do our own homework or pay someone reliable and honest to do it for us. Earnings forecasts are once again surging higher as the economic recovery takes hold. However, if the recovery is as slow over time as we expect it to be, future earnings reports will disappoint compared to the forecasts. The stock market rally has brought us back near to the level we were just before Lehman Bros. declared bankruptcy in September 2008, throwing the financial industry into utter chaos around the world. Where we go from here will depend greatly on real economic data, not equity analysts’ extreme optimism.
To view the McKinsey&Company report, please click on the following link: Equity analysts: Still too bullish.
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Gregg D. Killoren
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Equity Analysts Overly Optimistic, Slow to Adjust to Economic Changes: McKinsey Study
A recently updated study conducted by McKinsey&Company reveals that equity analysts are often too optimistic in their earnings forecasts and almost always lag behind changing economic conditions. Even worse, when economic conditions deteriorated, analysts were prone to making increasingly inaccurate predictions.
Despite a series of rules and regulations enacted 10 years ago to, among other things, restore investor confidence in earnings forecasts, nothing has changed. The U.S. Securities and Exchange Commission (SEC) Regulation Fair Disclosure (FD), passed in 2000, prohibits the selective disclosure of material information to some people but not others. The Sarbanes–Oxley Act of 2002 includes provisions specifically intended to help restore investor confidence in the reporting of securities’ analysts, including a code of conduct for them and a requirement to disclose knowable conflicts of interest. The Global Settlement of 2003 between regulators and ten of the largest US investment firms aimed to prevent conflicts of interest between their analyst and investment businesses.
McKinsey concludes that none of these regulatory changes has resulted in any improvement in earnings forecasts. “For executives, many of whom go to great lengths to satisfy Wall Street’s expectations in their financial reporting and long-term strategic moves, this is a cautionary tale worth remembering.”
Interestingly, the only occasions where earnings generally matched forecasts was in periods of strong economic growth. In other words, only when the economy surged did it meet the overly optimistic forecasts of equity analysts.
The take-away here for investors is that we must do our own homework or pay someone reliable and honest to do it for us. Earnings forecasts are once again surging higher as the economic recovery takes hold. However, if the recovery is as slow over time as we expect it to be, future earnings reports will disappoint compared to the forecasts. The stock market rally has brought us back near to the level we were just before Lehman Bros. declared bankruptcy in September 2008, throwing the financial industry into utter chaos around the world. Where we go from here will depend greatly on real economic data, not equity analysts’ extreme optimism.
To view the McKinsey&Company report, please click on the following link: Equity analysts: Still too bullish.
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