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Why Do We Listen to Analysts?
By JLP | May 11, 2009
Okay, I’m reading in the Wall Street Journal this morning about how stocks no longer look cheap. In the article they talk about how, according to most valuation measures, stocks are no longer cheap. The standard measure of a stock’s valuation is usually the P/E ratio, or the price/earnings ratio.
There are a couple of ways to use the P/E ratio. One is to use trailing earnings (earnings which have already been reported) and future earnings (earnings predicted in the future). As you can imagine, both measures are flawed. The first basically assumes that earnings will continue as is and the second is based on many assumptions that may or may not play out. For example, from the article:
Last October and November, for example, the S&P 500 appeared to be extremely cheap on that basis, trading below a P/E of 11. But it turned out that analysts had wildly overestimated the earnings for the year ahead.
Analysts had forecast 2009 S&P 500 operating earnings of $89 a share; that is now down to $57. But for 2010, the consensus calls for an almost 30% rebound.
So in the first paragraph they talk about how analysts wildly overestimated earnings and then in the VERY NEXT PARAGRAPH they tell us that analysts are calling for a 30% rebound for this year’s earnings. They were off by 36%! Yes, it’s difficult to predict the future. That’s the point! And yet, we listen to these analysts try to do it over and over again.
Am I the only one to see humor in this?
Topics: Investing, S&P 500 Index | 5 Comments »
May 11th, 2009 at 12:41 pm
The analysts you speak of are paid to give their opinions of the market sector they are studying. Problem is, too many times what the analysts say sounds like a statement of fact, not opinion. If they were all that good at predicting, they would be making money for themselves in the market rather than getting paid to opine. IMO, there are 3 states of a declarative statement. Either 1. you Think it or 2. you Know it or 3. you got it from a specified source. Too many times, the “I think” or “the source” is left off of statements.
May 11th, 2009 at 12:52 pm
What’s humorous to me is that an analyst can be dead wrong quarter after quarter, year after year. Then, once in a blue moon his forecast is spot on and we make a celebrity out of him. He appears on all the cable/TV shows and is widely quoted in the papers/mags. A new “guru” is born.
This is especially true when the prediction involves the general direction of the overall market.
May 11th, 2009 at 12:57 pm
I guess that people would rather listen to analysts flawed advice than not have any info at all.
May 11th, 2009 at 4:58 pm
I have to agree with Sam- it’s too scary to admit that the future is unpredictable and act accordingly. So, analysts are paid for inaccurate prodictions.
-Rick Francis
May 12th, 2009 at 9:07 am
What is sad is that analysts are extremely bright, motivated people. I hope the financial markets continue to remain difficult so these bright minds are driven to more useful professions like medicine or business.
When the S&P 500 multiple ranges from 6-26.. Even if earnings are spot on (which they aren’t) it is still nearly impossible to predict where the market is going.
If analysts are dead-on accurate and predict the S&P 500 forward earnings to be $50.. The multiple could be 8, which means the index should be at 400, OR if the multiple is more like 14, the index should be 700… That is quite a swing and a heck of a moving target. How about we use our brains and ingenuity to produce something TANGIBLE and USEFUL?