Analysts tend to be an optimistic breed – a fact well illustrated by the ‘snake’ chart below. Dating back to 1985, it plots each year’s consensus analysts’ forecasts for the earnings of s&p500 companies in the US, from the day the initial prediction was made (rebased to 100), through various revisions to the time reality became known. As you can see, the great majority of years snake downwards rather than up.
Source: Morgan Stanley as at September 2012
Whether they stem from an innate inclination among analysts to look on the bright side, from guidance offered by companies who would rather not admit profits may be flat or down until they absolutely have to or, most likely, from a combination of the two, these overly optimistic forecasts usually have to be dialled down as time goes by and hope is replaced by reality.
Rarely do companies fulfil the expectations analysts initially have for them – the upgrades of 2005 and 2006 being the principal exceptions as analysts underestimated the impact of china and the resources boom before, in any case, the credit crunch hit home – and, far more often, there are quite significant downgrades.
One notable aspect of this whole process is analysts seem not to be particularly disillusioned by earlier misses and the first forecast for a new year is very rarely lower than the corresponding one 12 months earlier. Even though they know they have been disappointed in their previous expectations, they are nevertheless optimistic about the following year – possibly to compensate for the earlier shortfall.
Like all the best charts, this one pretty much speaks for itself and we would certainly refrain from any additional comment about what it implies about current market expectations. Indeed, as value investors, we do not focus on current expectations and we shy away from analysts’ forecasts. This chart is a good illustration of why.