Study: Wall Street Analysts Still Exuberant in Their Earnings Projections
Researchers find that upward bias persists even after 2003 Global Analyst Research Settlement
“Previous studies suggest their stock recommendations do not perform well, and now we show that their long-term earnings per share growth rate forecasts are excessive and upwardly biased.” – from the study by J. Randall Woolridge and Patrick Cusatis, Penn State Smeal College of Business.
My observations:
First, let’s do our own research rather than depend on others to do it for us. We do not have to pay high fees to someone else to manage our money, particularly to brokers peddling flawed Street research.
Maybe we should get out of the forecasting business. Here’s what I would suggest.
- Use trailing 12-months earnings per share from continuing operations and before extraordinary items in the denominator of the price/earnings ratio. If you feel you have to use an earnings estimate, use the lowest estimate among the analysts offering forecasts for a margin of safety.
- Instead of using the Street’s consensus 5-year earnings forecast in the denominator of the PEG ratio (price/earnings divided by earnings growth rate), use a company’s internal or sustainable earnings growth rate calculated as follows: earnings retention ratio ((net income – dividends) / net income)) X return on equity.
