Consensus - Let's Agree we are all wrong - The Hyperion Effect

consensus1I love the expression “earnings consensus”. It is a fancy way of saying this is the average of all our guesses.

Reporting Season is just concluding in Australia so I thought we might take a look at some of the issues that surround the estimates of the analysts compared to what the companies report. The first stop I thought we would make is a reference to a post on this site late late last year. The post was titled Stupid Things Finance People Say, which included this ripper.

“Earnings missed estimates.”

No. Earnings don’t miss estimates; estimates miss earnings. No one ever says “the weather missed estimates.” They blame the weatherman for getting it wrong. Finance is the only industry where people blame their poor forecasting skills on reality. 

So as a starting point can we agree that when people state that earnings missed consensus estimates, it’s actually the other way around and the consensus estimates actually missed earnings? If you are with me so far, let’s keep going.

Over at The Big Picture blog of Barry Ritholtz he has a piece along the same lines warning about consensus, including a reference to the 10 rules of investing which includes Rule 9:

When all the experts and forecasts agree — something else is going to happen

As Stovall, the S&P investment strategist, puts it: “If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?”
Going against the herd as Farrell (Bob Ferrell, former chief stock market strategist at Merrill Lynch) repeatedly suggests can be very profitable, especially for patient buyers who raise cash from frothy markets and reinvest it when sentiment is darkest.

Then there was the recent article over at The Economist titled “The accuracy of equity research: Consistently wrong” The research also included a note about research becoming less reliable during falling markets than in rising ones

Roger Loh of Singapore Management University and René Stulz of Ohio State University looked at analysts’ forecasts of profits and the buy or sell recommendations they issued for the period 1983-2011. Their predictions, it turned out, were less reliable in falling markets than in rising ones, even after making allowances for increased volatility in such times. Analysts’ forecasts of profits for the next quarter were out by 46% more during periods of financial crisis than at other times, for instance.

So even after you spend time gathering all of the forecasts together to achieve consensus, on average this will be in in correct by around 50%. As our title suggests, perhaps the only thing we can get consensus on is that they are all wrong most of the time.

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