How accurate are investment forecasts?

New research from Australia and the US

Australian financial markets research specialist, East Coles, recently conducted a survey which revealed significant concerns over inaccurate forecasts, in part due to the perception of potential conflicts of interest between analysts and the investment banking and brokerage businesses of their employers*.

Fuelling these concerns was the absence of warnings over a number of high profile corporate collapses in Australia during the financial crisis, including the failures of Allco Finance, Babcock & Brown and ABC Learning Centres.

For instance, in September 2007, an analyst at a major investment bank reaffirmed his 'buy' rating on ABC Learning Centres (at the time one of the world's biggest listed child care centre operators) after the company announced plans for further global expansion and to increase fees^.

Within a few months of that 'buy' rating being issued, ABC's shares had collapsed from above $5 to zero and then, under the weight of $1.5 billion in debt, the company went into administration in November 2008.

In January 2008, an analyst from a high-profile Australian investment bank issued a report with an "outperform" recommendation on the Queensland property development group MFS and a 12-month price target of $7.15 from the then price of just under $4**. A week later, the shares had collapsed by 75 per cent to $1. MFS subsequently went into liquidation.

For sure, there are some accurate calls as well. But the East Coles survey found these are few and far between. 

McKinsey found similar evidence of persistent inaccuracy in US investment forecasts. It analysed earnings forecasts for US top 500 companies over a quarter century to the end of 2009, and found that with few exceptions aggregate earnings forecasts tended to exceed realised earnings per share^^.

Instead, the survey found that analysts typically lagged behind events, and that the most accurate expectations were actually those built into prices on capital markets themselves. 

Which reminds investors that the best - and least biased - estimate of expected returns on investment markets is those that are already built into market prices.

So instead of looking for answers in the analysts' forecasts, we suggest that you use your tried and true investment disciplines and stick with your personal strategic game-plan. It's bound to be an easier and clearer path to financial success.

* 'The Broking Analysts Who Make the Really Big Calls are Few and Far Between', The Melbourne Age, July 17, 2010 

^ 'Childcare Giant ABC Tipped to Lift Fees', The Courier Mail, Sept 15, 2007 

** 'Debacle at MFS a Lesson to Others', The Australian, Jan 21, 2008

^^ 'Equity Analysts: Still too Bullish', McKinsey on Finance, Number 35, Spring 2010, McKinsey & Company