It may be the most persistent criticism leveled against stock analysts: excessive optimism. It’s widely perceived that they tend to be more upbeat about the companies they cover than the facts justify.

However, a new study finds that when it comes to what may be analysts’ most closely followed work product — forecasts of current-quarter company earnings — the opposite tendency actually prevails.

“Analysts revise current earnings more often for bad than for good news,” says the report. “The analyst tends to omit positive news from current quarterly earnings forecasts while revising such forecasts [downward] in response to negative news.”

That’s not to suggest, though, that positive developments get discarded. It’s just that analysts often convey it in other ways than by raising their estimates of current earnings, according to the study’s authors, Zachary Kaplan and Charles Ham of Washington University of St. Louis and Philip Berger of the University of Chicago.

One alternate way is by revising stock-price targets upward. Another is by raising estimates of company earnings in future quarters. A third is simply through expressions of optimism about earnings without an outright revision.

Based on data covering the activity of 8,860 analysts in 71 quarters, the researchers report the likelihood of an upward revision of current earnings estimates to be about 13%, and that of a downward revision to be about 19.5%.

But when it came to revisions of stock-price targets and future-earnings estimates, the prevalence was the reverse: a 9.3% likelihood of downward revisions for the two items together, and an 11.2% chance of upward revisions.

In addition, a separate survey of brokerages’ reports to clients found that, without changing their forecasts, analysts did not refrain from explicitly predicting firms would miss or beat them, and that “beat” predictions outnumbered “miss” predictions by about 30%.

What accounts for these patterns? The professors surmise that in large part, it’s a desire to please top managers at the companies analysts cover. In keeping earnings forecasts low by not incorporating positive developments, analysts “cater to managers’ preferences for a walked-down [earnings] forecast pattern.”

The pattern the authors document, however, includes avoidance of walking up rather than only walking down. Non-earnings forecast signals are more prevalent for positive news than negative news, consistent with analysts responding to incentives to issue earnings forecasts managers will meet or beat.

In this regard, the study’s findings complement earlier research by other academics in which analysts were surveyed about their interactions with the firms they covered and reported feeling more pressure to lower earnings forecasts than to boost them.

The new paper suggests that such pressure from corporate managers can be very effective.

The practice of reporting positive news without incorporating it into more widely circulated earnings forecasts can, the study suggests, provide a significant advantage to brokerage clients over investors who don’t have access to analysts’ reports.

For example, on average an analyst’s upwardly revised stock-price target boosts by as much as 4.2% (depending on how it’s calculated) the likelihood that a company will beat the analyst’s on-the-record forecast of current quarterly earnings. This can provide a significant edge to the recipient of the optimistic price-target revision over an investor who knows only the unaltered earnings forecasts.

Why bother with this complex channeling of information? Why not simply raise earnings forecasts when there is good news as frequently as forecasts are lowered when there is bad news? Or, if good news does not justify raising an earnings forecast, why disseminate it at all?

In analysts’ role as financial intermediaries, the professors write, they serve multiple stakeholders who can have possibly conflicting demands for bias and precision. For instance, managers prefer beatable forecasts while investors demand accurate information. The analysis suggests that one way analysts may manage these conflicting demands is by “varying the forecasts into which they incorporate news.”

“Analysts convey optimism about current earnings in alternate ways that enable them to be of service to clients, whom they care about, and at the same time to avoid displeasing corporate managers, whom they also care about,” says Kaplan.

“True,” he adds, “providing information in these alternate ways excludes a broader public of non-clients. But given the complexity of analysts’ work and the general acceptance that brokerage is a business and not a public service, this would seem to be inevitable.”

Kaplan suggests, though, that the study does offer a lesson of potential importance to that broader public — namely, that widely circulated earnings forecasts, notwithstanding their value, may not be as informative as many people think.

The research draws on information from the Institutional Brokerage Data System, a major source of corporate and brokerage financial data. The study, entitled “Do Analysts Say Anything About Earnings Without Revising Their Earnings Forecasts?” appears in the March issue of The Accounting Review, a peer-reviewed journal published by the American Accounting Association.

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One response to “Analysts’ Current Earnings Forecasts Accentuate Bad News”

  1. A significant number of companies provide the lazy, investment banking driven analysts with earnings estimates that , worse case, they should be able to beat. What a racket that provides trading opportunities for investment firms. No wonder the number of sell side analysts are declining.

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