Wrong Kind of Consistency

February 10, 2017

Early in my career I was a "fundamental" analyst. This meant pouring through financial statements, digging into what made an industry work, making economic predictions, and then applying that to the earnings of a specific company. I quickly learned how hard it was to consistently be right (or even be within 10-20%) on a handful of companies I thought I knew. When I joined SEM I had designs of taking my fundamental accounting and credit analyst background and applying it to our portfolio management. My experience told me however, it is far easier to do this from a "top down" approach rather than a "bottom up" (company by company).

 

As I gained experience and studied market history I found the "rising tide lifts all boats (and sinks all ships)" analogy was especially true for the stock market. Somewhere above 90% of a stock's performance is tied to its industry and 90%+ of an industry's performance is tied to the underlying economy. It was over a decade in the making, but this is the core belief behind our "Dynamic" programs launched last year.

 

This has not stopped me from following analysts' earnings estimates. Besides being fascinated at how these "experts" come up with their numbers (there are so many behavioral biases that factor into these estimates it is really hard for me to take them seriously), it does help set expectations for the market (most market forecasts are based on projected earnings multiplied by an expected P/E ratio). One thing I've learned over the past 25 years of studying Wall Street's earnings estimates -- they are consistent. Unfortunately, it's not the kind of consistency that helps investors.

 

Here's a chart of the last few years of Wall Street Earnings estimates. The dotted lines are the estimates. The solid line is what actually happened.

It is easy to see the consistency of these "experts". They are.....

  • Consistently Optimistic

  • Consistently Wrong

Keep this in mind the next time you hear anything about earnings estimates & market projects based on those estimates.

 

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