Wall Street analysts are painting an awfully rosy picture of earnings growth, according to a study done by Penn State researchers. “[T]heir long-term earnings-per-share growth-rate forecasts are excessive and upwardly biased,” says J. Randall Woolridge, a professor of finance at the Smeal College of Business.
Over the period 1984 to 2006, analysts’ predicted EPS growth at an average of 14.7% for the long term (three to five years). Actual EPS growth: 9.1%.
On one-year forecasts, analyst projections fared a little better, but they were still overly optimistic: 13.8% instead of the actual rate of 9.8%.
So why is this happening?
Analysts’ employers want them to hype stocks so the brokerage can win commissions and underwriting deals. “This conflict of interest should have been squelched by former New York Attorney General Elliot Spitzer’s investigation and the $1.5 billion payment made by U.S. investment firms in the 2003 Global Analysts Research Settlements (GARS).” But the study found that GARS had no effect; analyst forecasts remained at their historic levels of about 15%.
Analysts don’t issue forecasts on stocks they don’t like.
Analysts becoming attached to the companies that they follow and, as a result, lose objectivity.