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36 The Forecasters Plague Lets retum to our analytical friends and look at their chances of success in terms of the inside view. As Table 54 makes clear, the odds of their being correct on their forecasts over any but the shortest periods of time are extremely low, which means the odds of making money consistendy using precise forecasts are almost negligible. As we saw earlier, the Street demands forecasts normally within a range of ±5%. Table 54, taken from our previous analysts forecasting study, shows how slim the probability of getting estimates within this range actually is. Remember, only 29% of forecasts were within this range in any one quarter. The table shows the odds of an analyst hitting the target for 1 quarter. * Kahneman noted it toolc eight more years after that discussion to complete the project. the outside view, the curriculum development expert was just as susceptible to the inside case.* As is now apparent, the inside and outside view draw on dramatically different sources of information, and the processes are poles apart. The outside view ignores the innumerable details of the project at hand (the cornerstone of analysis using the inside view) and makes no attempt to forecast the outcome of the project into the future. Instead, it focuses on the statistics of projects similar to the one being undertaken to garner the odds of success or failure. The basic difference is that, with the outside view, the problem is not treated as unique, but as an instance of a number of similar problems. The outside view could be applied to a large number of the problems weve seen in the past two chapters, including curriculum building, medical, psychiatric or legal diagnosis, as well as forecasting earnings or future stock prices. According to Kahneman, "It should be obvious that when both methods are applied with intelligence and skill the outside view is much more likely to yield a realistic estimate. In general, the future of long and complex undertakings is simply not foreseeable in detail." The number of possible outcomes when dozens or hundreds of factors interact in the marketplace is almost infinite. Even if one could foresee each of the possibilities, the probability of any particular scenario is negligible. Yet this is precisely what the analyst is trying to accomplish with a single, precise prediction.
5% 8 5      Any Surprise  Negative Surprise  Positive Surprise  1 quarter     4 quarters  1/130    10 quarters  1 / 200,000  1/110  1/58  20 quarters  1 / 50 biUion  1 /12,000  1 / 3,400  10% Su rise      Any Surprise  Negative Surprise  Positive Surprise  1 quarter     4 quarters  1/21    10 quarters  1 / 2,000  1/35  1 / 14  20 quarters  1 / 4 million  1 /1,250  1/200 
Source of data: AN Research Corp. (Formerly the research department of Abel Noser Corp.) and I/B/E/S, 19731996. 4 quarters, 10 quarters, and 20 quarters; for all eamings su rises in column 1, negative su rises in column 2, and positive su rises in column 3. It is not reassuring. The odds are staggering against the investor who relies on finetuned eamings estimates. There is only a I in 130 chance that the analysts consensus forecast will be within 5% for any four consecutive quarters. Going longer makes the odds dramatically worse. For any ten consecutive quarters, the odds of finetuning the estimates for a company within this range fall to I in 200,000, and for 20 consecutive quarters, 1 in 50 biUion. To put this in perspective, your odds are ten times greater of being the big winner ofthe New York State Lottery than of pinpointing eamings five years ahead. Few people would put a couple of bucks in a lottery with odds like these, but thousands of investors will play them in the marketplace. Some folks will say, "Who cares if eamings come in above estimates. In fact, Ill applaud." Fair enough. So we asked: what are the chances that you will avoid a 5% negative su rise for 10 to 20 consecutive quarters? Terrible. The investor has only a I in 7 chance of not getting a negative eamings su rise 5% below the consensus forecast after only four quarters. After ten quarters, the chances of not receiving at least one cripphng eamings su rise go down to I in 110, and for 20 quarters, they are 1 in 12,000. Yet, as we have also seen, forecasts often have to Table 54 The Probability Game The Chances of a Stock Surviving Without an Eamings 8 5
go out a decade or more to justify the high prices at which many companies are trading. Even if we stretched the acceptable forecast band to 10%, which we saw is too imprecise for many stockpickers, the chance of consistently having accurate forecasts is still only 1 in 21 for four quarters, 1 in 2,000 for years, and 1 in 4 million for 5 years. Think about itshould anyone sane want to play against these odds? Yet, as we know, relying on accurate estimates is the way most people play the investment game. Investors who realize the odds will obviously go with them if there is a way to do it, which is exactly what well look at in the next section. What we see here is a classic case of using the inside rather than the outside view. Evidence such as the above strongly supports Kahnemans statement that the outside view is much more likely to yield realistic results. Yet, as Kahneman states, "The inside view is overwhelmingly preferred in forecasting." Looking at the figures above, we might all ask why. The answer, again, is psychological. The natural way a decisionmaker approaches a problem is to focus all of his or her knowledge on the task, concentrating particularly on its unique features. Kahneman noted that a general observation of overconfidence is that, even when forecasters are aware of findings such as the foregoing, they will still use the inside approach, disregarding the outside view, regardless of how strong its statistical documentation. Often, the relevance of the outside view is explicitly denied. Analysts and money managers I have talked to about high error rates repeatedly shrug them off. Usually, the problem is attributed to unreliable information from company managements, extraordinary circumstances, or not having been thorough enough (by failing to integrate even more complex and elusive variables into an analysis already severely overloaded with information). In sum, they ignore the record of forecasting, because they have been taught and believe that investment theory, when executed properly, will yield the precise results that they require. Analysts and money managers seem unable to recognize the problems inherent in forecasting. This situation is not unique to Wall Street. Indeed, the relevance of the statistical calculations inherent in the outside view is usually explicitly denied. Doctors and lawyers often argue against allying statistical odds to particular cases. Sometimes their preference for the inside view is couched in almost moral terms. Thus, the professional will say, "My client or patient is not a statistic, his case is truly unique." Many disciplines implicitiy teach their practitioners that the inside view is the only professional way to come to grips with the unique problems they will meet. The outside view is rejected as a crude analogy from instances that are only superficially similar.
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