The Investment Scientist

Should You Trust Wall Street Analyst Forecasts?

Posted on: January 20, 2020

Part of Wall Street analysts’ job is to make earning forecasts of covered firms so as to guide investors’ actions. In 1996, Professor Rafael La Porta discovered an interesting phenomenon: the better the forecasts, the worse the returns! Twenty years have passed since his last paper, now we have two more decades of data. Does the new data confirm or contradict his original discovery? Well, see this graph, which I lifted right from his new paper.

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Lo LTG is the average return of the 10% of stocks that have the lowest analyst forecasted earning growth, and Hi LTG is the average return of the 10% of stocks that have the highest analyst forecasted earning growths. The result confirms his original discovery! The better the forecasts, the worse the returns!

Not only that, Hi LTG stocks are also much more volatile (riskier)  than Lo LTG stocks. See the table below (last column.)

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The Hi LTG stock portfolio has a 36.3% standard deviation, this high volatility produces a 6.6% return drag. No wonder, if you invested $1000 in the Hi LTG portfolio (high growth stocks recommended by analysts) in 1981 and every year after, you would only get $7,500 in 2015. If you invested in the Lo LTG portfolio (low growth stocks not recommended by analysts) every year, you would get $117,000. A whopping 15-times difference in 34 years!

Trust those analysts if you don’t like money!!!

 

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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