New York, NY – According to a recently published study by McKinsey & Company, Wall Street analysts have remained overly optimistic in the past decade, despite extensive regulatory developments during that period which attempted to improve the quality of sell-side research, and reduce the conflicts of interest inherent in conducting equity research on companies while also providing investment banking services to those issuers.
The McKinsey Study
The McKinsey study is an update of one conducted ten years ago which revealed that sell-side analysts’ recommendations were much too bullish when compared to actual results. The current study reveals that little if anything has changed in the ensuing period.
McKinsey reports that over the past 25 years, Wall Street analysts’ earnings estimates have been on average 100% too high. This reflects earnings estimate growth ranging from 10% to 12% per year, compared to actual earnings growth of 6%. The McKinsey study found that over the 25 year period, Wall Street analysts’ forecasts have been lower than actual in only two periods during the earnings recovery following recessions.
Measured in a different way, the implied price-to-earnings ratio of analysts’ forecasts has been 25% higher than the actual P/E ratio of the S&P 500. The only period where analysts’ implied P/E ratio estimate was lower than the market was during the dot com bubble of 1999 to 2001 when the stock market soared on unfounded optimism.
While one could argue that this study might suggest that the conflicts of interest inherent in investment bank research have not really been effectively addressed, another simpler explanation might be at work. Post Reg FD, Wall Street analysts have gotten much of their sense of companies’ near-term earnings prospects from corporate management guidance. The fact that Wall Street earnings estimates remains overly optimistic could be because of human nature. Both company management and the analyst community are too bullish about the prospects of the companies they manage, or the stocks they cover.
For more details on the McKinsey study, click on the following link.