fer to underwritings of the firm being offered to its clients in "Grubman units" of $2.5 million each.

Needless to say. Wall Streeters often give top analysts the same adulation that teenagers reserve for rock stars and film heroes. Also needless to say, la creme, selected from over 15,000 analysts across the country, are sensational stock-pickers.

Arent they?

Financial World measured the analysts results some years back. The article stated, "It was not an easy task. Most brokerage houses were reluctant to release the batting averages of their superstars." In many cases, the results were gotten from outside sources, such as major clients, and then "only grudgingly." After months of digging, the magazine came up with the recommendations of 20 superstars.

The conclusion: "Heroes were few and far between-during the period in question, the market rose 14.1 percent. If you had purchased or sold 132 stocks they recommended, when they told you to, your gain would have been only 9.3 percent," some 34 percent worse than selecting stocks by throwing darts. The magazine added, "Of the hundred and thirty-two stocks the superstars recommended, only 42, or just over 1/3, beat the S&P 500." A large institutional buyer of research summed it up. "In hot markets the analysts ... get brave at just the wrong time and cautious just at the wrong time. Its uncanny, when they say one thing, start doing the opposite. Usually you are right."*

In addition to superstars, professional investors rely on earnings forecasting services such as I/B/E/S, Zacks, and First Call, who have on-line features to give the pros instant revisions of estimates. First Call provides a service that also gives money managers, as well as competing analysts, all analysts reports immediately upon their release. Many of these reports deal with forecast changes. Over 1,000 companies are covered. Changes in analysts estimates are prime items on the financial news networks such as CNBC and CNN-FN. Investors from the managers of multi-biUion-dollar pension funds to the average Joe act quickly on changes in analyst forecasts or eamings su rises, which are flashed immediately by the wire services and other financial media. Near-term eamings estimates, as noted, are the major trigger of investment decisions today.

The requirement for precise eamings estimates has been increasing in recent years. Missing the analysts estimates by pennies can send a stocks price down 8 1 . Better-than-expected eamings can send prices soaring. How good, then, are these estimates? Weve already seen the performance of the Institutional "All Stars." But this was only for a one-year period. Nobodys perfect: Was this a one-time slip? To answer

The Forecasting Follies

Should analysts estimates have the influence on contemporary investors that they do, or are they a guaranteed way of losing money, as some professionals claim? There is a clear-cut answer to this question.

Updating the work in the New Contrarian Investment Stretegy, as well as a number of articles in Forbes and elsewhere, I did a study in collaboration with Michael Berry of James Madison University on analysts forecasts, which was published in The Financial Analysts Joumal in May/June 1995.* It examined brokerage analysts quarterly forecasts of eamings as compared to eamings actually reported between 1973 and 1991, which has subsequently been updated to 1996. Estimates for the quarter were usually made in the previous three months, and analysts could revise their estimates up to two weeks before the end of the quarter. In all, 94,251 consensus forecasts were used, and we required at least four separate analysts estimates before including a stock in the study. Larger companies, such as Microsoft or Exxon, might have as many as 30 or 40 estimates. More than 1,500 New York Stock Exchange, Nasdaq, and AMEX companies were included, and on average, there were about 1,000 companies in the sample. The study was, to my knowledge, the most comprehensive on analyst forecasting to date.

How do analysts do at this game, where even slight errors can result in instant wipeouts? A glance at Figure 5-1 tells all. The results are startling-analysts estimates were sharply and consistently off the mark, even though they were made less than three months before the end ofthe quarter for which actual eamings were reported. The average error for the sample was a whopping 44% annually. Again, this was no small sample: it included approximately 500,000 individual analysts estimates.

Interestingly, these large errors are occurring in the midst of the information revolution. In the early 1970s, when I was an analyst, nothing was on-line. Today, the analysts at major brokerage houses have immediate access to the reports of competitors, estimate changes, and volumes of other information. There is exponentially more information available today than in the early 1970s. Its like moving from a hand-cranked telephone to a miniature cellular. Yet in spite ofthe information revolution, estimates seem to have gotten worse, not better, as the hori-

this question, well next look at the long-term analyst forecasting record. This will be important to the investment strategies considered in the chapters ahead.

60% -

Average Analysts Error: 44% Median Analysts Error: 42%

1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996

Year

Source of data: A-N Research . (Formerly the research department of Abel Noser .) and I/B/E/S, 1973 - 1996

zontal lines on the chart indicate. In the last eight years of the study, the average error was an astounding 50% and in two of those years, 57% and 65% respectively.

Since many market professionals believe that a forecast error of plus or minus 5% is large enough to trigger a major price movement, what did a miss of 57% in 1989 or one of 65% in 1990 do? When we look at the price drops on sizzling stocks after analyst misses, at times of only a few percent, it becomes apparent that estimate errors even this small are dangerous to your investment health. Yet, this is precisely how the game is played on the Street, by analysts, by the large mutual funds, pension funds, other institutional investors, and by average investors. But before we draw any further conclusions, well look at some other results from the study.

You might wonder whether the results are skewed by a few large errors. To check for this kind of skew, we measured earnings 8 18 8

Figure 5-1

Forecast Error as a Percent of Reported Eamings

1973 - 1996