A hard knock life why analyst accuracy falls short
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A Hard Knock Life: Why Analyst Accuracy Falls Short. QWAFAFEW May 25, 2010 Carson Boneck CFA, David Pope CFA. Abstract.

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A hard knock life why analyst accuracy falls short

A Hard Knock Life: Why Analyst Accuracy Falls Short

QWAFAFEW

May 25, 2010

Carson Boneck CFA, David Pope CFA


Abstract

Abstract

It is a commonly held belief among investors that there is persistence in security analyst's EPS forecast accuracy.  Studies by Clement and Brown examine persistence directly and show that, at least in the pre Reg-FD period, there is a measurable amount of analyst accuracy persistence.  We confirm this work and extend it to the Post-FD period, to the international markets, and then focus on the market profitability associated with persistence.

Perhaps to many practitioners' (non quants) surprise, we find that persistence is not all that it is believed to be.  We show that while persistence is statistically measurable, it has very limited usefulness in predicting the future accurate analysts.  Our work shows that using past accurate analysts forecasts leads to somewhat better results than the naive mean, but falls well short of alternative methods.  Our work explores the metrics that make forecasts accurate rather than the individuals that make the forecasts themselves.


Agenda

Agenda

  • Validate Clement / Brown Work

    • Update for Post Reg FD

  • Isolate importance of Past Skill

  • Past skill as indicator of future accuracy

  • Compare alternative metrics of forecasting:

    • Rock Stars, Time Weighted, Naïve Mean, BEST

  • Q&A


How good are the experts really

How Good are the “Experts”, really?


We want to believe lead analyst syndrome

We want to BELIEVE – “Lead Analyst” Syndrome

  • The reality is forecasting is hard

  • Part of an Analyst’s role is to get noticed or get “shelf space”

  • To be the most accurate, a forecast by definition has to be an outlier or bold forecast

  • Analysts typically form their reputation by making one BIG call rather than being consistently right – Is Abby Joseph Cohen Accurate?

  • Surprisingly clients we spoke with had never actually looked at Analysts’ accuracy themselves

  • People like to believe in persistence of skill, or performance when it counts, often citing sports case studies

    • Hot Hand in Basketball - Gilovich, Vallone & Tversky (1985)

    • Clutch Hitting in Baseball – Cramer (1977)


Perfect foresight is very profitable

Perfect Foresight is Very Profitable


Clement brown accuracy persistence

Clement / Brown – Accuracy Persistence


Clement brown accuracy persistence top decile

Clement / Brown – Accuracy Persistence (Top Decile)


Isolate age regress on accuracy

Isolate Age – Regress on Accuracy


Isolate accuracy regress on age

Isolate Accuracy – Regress on Age


Skill looks to mean revert 1990 2009

Skill Looks to Mean Revert (1990 – 2009)


Post fd story is the same 2001 2009

Post FD – Story is the Same (2001-2009)


In the not so long run all analysts are average

In the (not so) Long-Run All Analysts Are Average


High t stat low r 2 explaining a lot of nothing

High T-Stat, Low R^2 – Explaining a lot of nothing

  • Quantitative Slight of Hand

    • Neither Clement or Brown ever show R^2’s on past accuracy, only multiple regressions

  • Analogy:

    Think about medicine as an example. Maybe they can find out that coffee drinking has a statistically significant and even important effect on the probability of heart disease, but still not be able to predict whether or not you will suffer from heart disease, regardless of your coffee-drinking habits.

    - Leamer


How do you define accuracy

How Do You Define Accuracy

  • Two Definitions of Accuracy

    • Demeaned Accuracy

      - Allows easy comparisons across stocks, time

      - [Abs(Estimate – Actual) – Abs(Average Error) ] / Abs( Avg Error)

    • Accuracy relative to Actual

      - Probably the first thing most investors think about when considering accuracy

      - Abs(Estimate – Actual) / Abs(Actual)


Rockstars mean revert post fd avg error rockstar 0 timeweighted 16

Rockstars Mean Revert (Post FD)Avg Error RockStar = 0, TimeWeighted = -.16


Rockstar analysts are bold but not accurate

“RockStar” Analysts are BOLD, but not Accurate


The reality of analysts lack of accuracy

The Reality of Analysts’ (Lack of) Accuracy


Even rockstars don t beat na ve mean consensus

Even “Rockstars” don’t beat Naïve Mean Consensus


What then makes a forecast more accurate

What, then, makes a Forecast more Accurate?

  • We know Analysts are not Accurate; they have more error than a naïve consensus

  • Literature proves us a guide into other areas

    • Clement, Lee

Importance:

1000

Importance:

100

Importance:

10

Tenure

Broker Size

Estimate Age


Alternative focus on factors that make forecast accurate

Alternative – Focus on Factors that Make Forecast Accurate


Similar results internationally

Similar Results Internationally


Beware

Beware….

  • Forecast Accuracy is not the same as market impact

    • Take an average analyst at a top brokerage

    • Compare to a skilled unknown analyst at a brokerage we never heard of…..

    • Analyst typically establish their reputation on ONE big call

    • II Analysts (Institutional Investor) Poll


A hard knock life why analyst accuracy falls short

Bibliography

Bagnoli, Levine, Watts, 2003,”Analyst Estimation Revision Clusters and Corporate Events, Parts I and II”, Working Paper

Beaver, Cornell, et al, 2008,” The Impact of Analysts’ Forecast Errors and Forecast Revisions on Stock Prices”, Journal of Business Finance & Accounting, 35(5) & (6), 709–740

Brown, Lawrence, 2001, “How Important is Past Analyst Forecast Accuracy?”, Financial Analysts Journal, Vol 57, pp 44-49.

Chan, Jegadeesh, Lakonishok, 1996, “Momentum Strategies “, Journal of Finance

Clement, M. B., 1999. “Analyst forecast accuracy: Do ability, resources, and portfolio complexity matter?”, Journal of Accounting and Economics, 27 (3): 285-303.

Clement, Tse, 2003, “Do Investors Respond to Analysts' Forecast Revisions as If Forecast Accuracy Is All That Matters?”, The Accounting Review, Vol. 78 (1), 227-249

Doyle, Lundholm, Soliman, 2006, “The Extreme Future Stock Returns Following I/B/E/S Earnings Surprise”, Journal of Accounting Research, 44 (5)

Elgers, P., M. Lo, and R. Pfeiffer,J r, 2001, “Delayed security price adjustment to financial analysts' forecasts of annual earnings”, The Accounting Review, 76 (4): 613-632.

Gleason, C., and C. Lee, 2003, “Analyst forecast revisions and market price discovery”, The Accounting Review, 78 (1): 193-225.

Mikhail, Walther, Lewis, 1999, “Does Forecast Accuracy Matter to Security Analysts?”,The Accounting Review, Vol. 74( 2), pp. 185-200

Sinha, Brown, Das, 1997, “A Re-Examination of Financial Analysts’ Differential Earnings Forecast Accuracy”, Contemporary Accounting Research; 14, 1;


Interesting stats us fy1

Interesting Stats – US: FY1


Interesting stats intl fy1

Interesting Stats – Intl: FY1


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