Why should I beware of using analyst forecasts?

We believe that we have some of the highest quality analyst data available on the market. That said, while they can be useful, broker estimates should always be used carefully. They are likely to have more value as a guide to market expectations than as a guide to the future.

Behavioural scientists have shown repeatedly that experts in every field are poor forecasters. They are inaccurate, over confident and slow to change their opinion. As we discuss here, equity research analysts are no exception, and studies by GMO has shown that their forecasts tend to lag reality. Analysts tend to raise forecasts too slowly in good markets, and reduce them too slowly in bad markets.

Additionally, broker recommendations have exhibited a strong upward bias historically. Researchers found that sell or strong sell recommendation made up less than 5% of all recommendations over the 1985 to 1999 period. This is because most sell-side analysts work for brokerage houses which often have strong investment banking franchises, creating potential conflicts of interest.

Following the debacle of the late 1990s, legislators took action to address this - although this appears to have had some impact, recent studies show that recommendations still have remained relatively optimistic.

We discuss the nuances of strategies relating to broker forecasts in more depth in the following articles: