Those Failing Analysts

This is a great chart from Ed Yardeni.  It shows a 20 year history of analyst’s estimates and how poorly the estimates have held up over the course of each year.  As you can see, analyst’s estimates have fallen during the year in 16 of the 20 years.  In other words, the estimates are revised lower in most years as analysts are forced to cut estimates.

Having had a significant amount of experience in this field, I presume there’s a bit of cat and mouse here as corporate America tends to play the analysts by feeding them low estimates and then beating the estimates.  But as another earnings season approaches we have to all question the significance of what will certainly be a recurring headline in the coming weeks:

“ABC company beats expectations!”

Here’s more from Dr. Ed:

I track the industry analysts’ annual consensus earnings estimates of the S&P 500 for the current year and the coming year on a weekly basis. I call them “Earnings Squiggles” because that’s what they look like. As of last week, industry analysts estimated that the S&P 500 will earn $112.98 this year and $125.91 in 2014.

The estimates for 2012 and 2013 mostly fell all last year, yet the S&P 500 rose 13.4%. I have the Squiggles data back to 1979 on a monthly basis. More often than not, they tend to trend down; yet more often than not, the market has trended higher. That’s because the market discounts 12-month forward consensus expected earnings. A good proxy for this concept is forward earnings, i.e., the time-weighted average of consensus estimates for the current and coming years. It tends to be a good 12-month leading indicator for actual profits, with one important exception: Analysts don’t see recessions coming until we all do too.

The bottom line is that the bottom line for S&P 500 companies on a 12-month (and on a 52-week) forward basis rose to a record high at the beginning of this year even though analysts have been lowering their estimates for 2012 and 2013.

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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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Comments

  1. But, how will we get the lemmings to buy stocks if we don’t say that earnings were “better than expected”?

  2. In order to make the market always look “cheap”, it is always beneficial to have forward PE’s that support that thesis. Explains why we always hear about forward PE’s from pundits and analysts.

    Who pays these analysts for their forecasts?

    Sometimes just following the money shows you the path to the truth.

  3. Can someone help me interpret that graph? It looks to me like the 12-month forward consensus earnings expectations tends to head in the correct direction, even if the actual results are lower (represented by the “actual 4Q sum”).

  4. I’ve always felt that analysts are ALWAYS optimistic, and this would back that up.

    I also think that they traditionally do a poor job of predicting recessions, and this would confirm that too.

    By the very nature of their jobs (i.e., focusing laser like on a particular company or segment), they tend to miss some of the macro issues that can foreshadow recessions.

  5. “By the very nature of their jobs (i.e., focusing laser like on a particular company or segment), they tend to miss some of the macro issues that can foreshadow recessions.”

    This is a big point (though it is more accurate to talk about missing general inflection). Talk to most bottom-up investors/analysts, and they avoid any macro talk like the plague.

    More importantly, sell-side analysts aren’t paid on their ability to forecast. Sadly, many sell-siders and buy-siders don’t even understand this.

  6. Would be nice to see this presentation back to 1979.

    Overall, earnings on a long term average have increased nicely since 1995.

    Investors – no worries, speculators – beware.