When revising their predictions of companies’ current quarterly earnings, financial analysts are more likely to highlight the negatives instead of the positives, according to new research.
“Analysts revise current earnings more often for bad than for good news, consistent with not incorporating good news into short-horizon earnings forecasts,” said the study by Zachary R. Kaplan and Charles G. Ham of Washington University of St. Louis and Philip G. Berger of the University of Chicago, “The analyst tends to omit positive news from current quarterly earnings forecasts while revising such forecasts [downward] in response to negative news.”
The study appears in the March issue of The Accounting Review, a journal of the American Accounting Association. The researchers examined the activity of approximately 9,000 analysts across 71 quarters and found the likelihood of an upward revision of current earnings estimates to be around 13 percent, and of a downward revision to be about 19.5 percent, a 50 percent greater probability on the down side.
When revising stock-price targets and future-earnings estimates, the opposite was true, with the likelihood of downward revisions for both items together being 9.3 percent and of upward revisions 11.2 percent, a 20% greater probability on the up side. A separate survey of brokerage reports to clients found, however, that without changing their forecasts, financial analysts didn’t avoid explicitly predicting companies would miss or beat the forecasts, but the “beat” predictions outnumbered “miss” predictions by approximately 30 percent.
In trying the explain these patterns, the researchers theorized that, for the most part, the reluctance of analysts to revise their earnings forecasts upwards — and instead to provide alternative, upbeat predictions separately — comes from a desire to please top executives at the companies they cover. In keeping earnings forecasts low by not including positive developments of which they’re aware, analysts “cater to managers’ preferences for a walked-down [earnings] forecast pattern,” said the study. “The pattern we document, however, includes avoidance of walking up rather than only a walk-down…Non-earnings forecast signals are more prevalent for positive news than negative news, consistent with analysts responding to incentives to issue [earnings] forecasts managers will meet or beat.”
Reporting positive news without putting it in more widely circulated earnings forecasts can offer an important advantage to brokerage clients over investors who don’t have access to analyst reports, the study pointed out. For example, an upwardly revised stock-price target by an analyst increases the likelihood that a company will beat the analyst’s on-the-record forecast of current quarterly earnings by as much as 4.2 percent, depending on how it is calculated. That can give a significant edge to the recipient of the optimistic price-target revision, as opposed to an investor who only knows the unchanged earnings forecasts.