No executive would dispute that analysts’ forecasts serve as an important benchmark of the current and future health of companies.
To better understand their accuracy, we undertook research nearly a decade ago that produced sobering results. Analysts, we found, were typically overoptimistic, slow to revise their forecasts to reflect new economic conditions, and prone to making increasingly inaccurate forecasts when economic growth declined.
Alas, a recently completed update of our work only reinforces this view — despite a series of rules and regulations, dating to the last decade, that were intended to improve the quality of the analysts’ long-term earnings forecasts, restore investor confidence in them, and prevent conflicts of interest.
Analysts have been persistently overoptimistic for the past 25 years, with estimates ranging from 10% to 12% a year, compared with actual earnings growth of 6%.
On average, analysts’ forecasts have been almost 100% too high. Capital markets, on the other hand, are notably less giddy in their predictions. Except during the market bubble of 1999–2001, actual price-to-earnings ratios have been 25% lower than implied P/E ratios based on analyst forecasts.
Executives, as the evidence indicates, ought to base their strategic decisions on what they see happening in their industries rather than respond to the pressures of forecasts, since even the market doesn’t expect them to do so.
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