Can regulation improve analysts’ forecasts? – Can you guess what we think about that question?


Jamie Lowry

Jamie Lowry

Fund Manager, Equity Value

Last week, in ‘Sell’ preservation society, we tiptoed around the possibility analysts might occasionally pull their punches on company research for fear of upsetting colleagues in more profitable parts of the investment banking world. This time we return to more familiar ground by suggesting there is no point relying on analysts’ forecasts – no matter how impregnable their employers’ Chinese walls may be.

That we will regularly express our belief human beings are no good at forecasting, regardless of their area of expertise, is – ironically enough – one of the more predictable things about The Value Perspective. Our starting point this time is an academic paper with the fairly self-explanatory title ‘Did analyst forecast accuracy and dispersion improve following the increase in regulation post 2002?’

More accurately, since the paper has yet to be published, our starting point is a Bloomberg article that – spoiler alert – rather answers that question with its own title, Analyst crackdown did nothing to improve US earnings forecasts. Anyway, the paper essentially investigates whether the 2002 Sarbanes-Oxley regulation on conflicts of interest on Wall Street led to more accurate forecasts by analysts.

There is a line of thought that one reason analysts used not to make accurate forecasts in the past is because of the sort of potential conflicts we touched on in ‘Sell’ preservation society. If that were true, one might reasonably assume the measures the Sarbanes-Oxley Act introduced in the US in 2002 would have led to some improvement in forecasting accuracy. One would assume wrongly.

According to Bloomberg, the paper measured two values between 1994 and 2013 – how far analyst projections veered from actual results (forecast error), and how much analysts differed from each other (dispersion). “Both worsened by more than two percentage points between 2000 and 2013,” the article continues, “with the average estimate missing its target by 35%, compared with 33% before.”

So why might this be? Again we will have to rely on Bloomberg, which tells us: “Several explanations are possible for the deterioration, the authors speculated. Among them – analysts got lazy after the spotlight on their work faded, or companies don’t release enough data to make forecasting results possible.”

Thus, as one of the paper’s co-authors told Bloomberg: “If the quality of the information coming out of the financial reports analysts have access to is not where it should be, they’re not going to be as accurate and unbiased as they should be.” In other words, it is the fault of the companies for not releasing the appropriate amount or quality of information.

Well, perhaps – although, here on The Value Perspective, another possibility does occur. Since there is no mention of it in the article, however, we must await the publication of the paper itself to see if there is any suggestion that, no matter what regulation is in force and how much or how little information is available, human beings are just very bad at forecasting. But of course you knew we would say that.


Jamie Lowry

Jamie Lowry

Fund Manager, Equity Value

I joined Schroders in 2004 as an equity analyst in the European Equity Team initially specializing in the Industrial sectors before moving on to Consumer-based companies and finally Insurance. In 2007, I became a co-manager on a fund investing in undervalued European companies and took on sole responsibility for the fund in May 2010. Prior to joining Schroders, I worked at Hedley & Co Stockbrokers and Deutsche Asset Management as a trainee analyst.

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