1. 1SystematIQ Research| Capital IQ, A Standard & Poor’s Business Friday, October 23, 2015 A Hard Knock Life: Why Analyst Accuracy Falls Short QWAFAFEW May 25, 2010 Carson Boneck CFA, David Pope CFA

2. 2SystematIQ Research| Capital IQ, A Standard & Poor’s Business Abstract It is a commonly held belief among investors that there is persistence in security analyst's EPS forecast accuracy. Studies by Clement and Brown examine persistence directly and show that, at least in the pre Reg-FD period, there is a measurable amount of analyst accuracy persistence. We confirm this work and extend it to the Post-FD period, to the international markets, and then focus on the market profitability associated with persistence. Perhaps to many practitioners' (non quants) surprise, we find that persistence is not all that it is believed to be. We show that while persistence is statistically measurable, it has very limited usefulness in predicting the future accurate analysts. Our work shows that using past accurate analysts forecasts leads to somewhat better results than the naive mean, but falls well short of alternative methods. Our work explores the metrics that make forecasts accurate rather than the individuals that make the forecasts themselves.

3. 3SystematIQ Research| Capital IQ, A Standard & Poor’s Business Agenda Validate Clement / Brown Work ›Update for Post Reg FD Isolate importance of Past Skill Past skill as indicator of future accuracy Compare alternative metrics of forecasting: ›Rock Stars, Time Weighted, Naïve Mean, BEST Q&A

4. 4SystematIQ Research| Capital IQ, A Standard & Poor’s Business How Good are the “Experts”, really?

5. 5SystematIQ Research| Capital IQ, A Standard & Poor’s Business We want to BELIEVE – “Lead Analyst” Syndrome The reality is forecasting is hard Part of an Analyst’s role is to get noticed or get “shelf space” To be the most accurate, a forecast by definition has to be an outlier or bold forecast Analysts typically form their reputation by making one BIG call rather than being consistently right – Is Abby Joseph Cohen Accurate? Surprisingly clients we spoke with had never actually looked at Analysts’ accuracy themselves People like to believe in persistence of skill, or performance when it counts, often citing sports case studies ›Hot Hand in Basketball - Gilovich, Vallone & Tversky (1985) ›Clutch Hitting in Baseball – Cramer (1977)

6. 6SystematIQ Research| Capital IQ, A Standard & Poor’s Business Perfect Foresight is Very Profitable

7. 7SystematIQ Research| Capital IQ, A Standard & Poor’s Business Clement / Brown – Accuracy Persistence

8. 8SystematIQ Research| Capital IQ, A Standard & Poor’s Business Clement / Brown – Accuracy Persistence (Top Decile)

9. 9SystematIQ Research| Capital IQ, A Standard & Poor’s Business Isolate Age – Regress on Accuracy

10. 10SystematIQ Research| Capital IQ, A Standard & Poor’s Business Isolate Accuracy – Regress on Age

11. 11SystematIQ Research| Capital IQ, A Standard & Poor’s Business Skill Looks to Mean Revert (1990 – 2009)

12. 12SystematIQ Research| Capital IQ, A Standard & Poor’s Business Post FD – Story is the Same (2001-2009)

13. 13SystematIQ Research| Capital IQ, A Standard & Poor’s Business In the (not so) Long-Run All Analysts Are Average

14. 14SystematIQ Research| Capital IQ, A Standard & Poor’s Business High T-Stat, Low R^2 – Explaining a lot of nothing Quantitative Slight of Hand ›Neither Clement or Brown ever show R^2’s on past accuracy, only multiple regressions Analogy: Think about medicine as an example. Maybe they can find out that coffee drinking has a statistically significant and even important effect on the probability of heart disease, but still not be able to predict whether or not you will suffer from heart disease, regardless of your coffee-drinking habits. - Leamer

15. 15SystematIQ Research| Capital IQ, A Standard & Poor’s Business How Do You Define Accuracy Two Definitions of Accuracy ›Demeaned Accuracy - Allows easy comparisons across stocks, time - [Abs(Estimate – Actual) – Abs(Average Error) ] / Abs( Avg Error) ›Accuracy relative to Actual - Probably the first thing most investors think about when considering accuracy - Abs(Estimate – Actual) / Abs(Actual)

16. 16SystematIQ Research| Capital IQ, A Standard & Poor’s Business Rockstars Mean Revert (Post FD) Avg Error RockStar = 0, TimeWeighted = -.16

17. 17SystematIQ Research| Capital IQ, A Standard & Poor’s Business “RockStar” Analysts are BOLD, but not Accurate

18. 18SystematIQ Research| Capital IQ, A Standard & Poor’s Business The Reality of Analysts’ (Lack of) Accuracy

19. 19SystematIQ Research| Capital IQ, A Standard & Poor’s Business Even “Rockstars” don’t beat Naïve Mean Consensus

20. 20SystematIQ Research| Capital IQ, A Standard & Poor’s Business What, then, makes a Forecast more Accurate? We know Analysts are not Accurate; they have more error than a naïve consensus Literature proves us a guide into other areas Clement, Lee Estimate Age Broker Size Tenure Importance: 1000 Importance: 100 Importance: 10

21. 21SystematIQ Research| Capital IQ, A Standard & Poor’s Business Alternative – Focus on Factors that Make Forecast Accurate

22. 22SystematIQ Research| Capital IQ, A Standard & Poor’s Business Similar Results Internationally

23. 23SystematIQ Research| Capital IQ, A Standard & Poor’s Business Beware…. Forecast Accuracy is not the same as market impact ›Take an average analyst at a top brokerage ›Compare to a skilled unknown analyst at a brokerage we never heard of….. ›Analyst typically establish their reputation on ONE big call ›II Analysts (Institutional Investor) Poll

24. 24SystematIQ Research| Capital IQ, A Standard & Poor’s Business Bibliography Bagnoli, Levine, Watts, 2003,”Analyst Estimation Revision Clusters and Corporate Events, Parts I and II”, Working Paper Beaver, Cornell, et al, 2008,” The Impact of Analysts’ Forecast Errors and Forecast Revisions on Stock Prices”, Journal of Business Finance & Accounting, 35(5) & (6), 709–740 Brown, Lawrence, 2001, “How Important is Past Analyst Forecast Accuracy?”, Financial Analysts Journal, Vol 57, pp 44-49. Chan, Jegadeesh, Lakonishok, 1996, “Momentum Strategies “, Journal of Finance Clement, M. B., 1999. “Analyst forecast accuracy: Do ability, resources, and portfolio complexity matter?”, Journal of Accounting and Economics, 27 (3): 285-303. Clement, Tse, 2003, “Do Investors Respond to Analysts' Forecast Revisions as If Forecast Accuracy Is All That Matters?”, The Accounting Review, Vol. 78 (1), 227-249 Doyle, Lundholm, Soliman, 2006, “The Extreme Future Stock Returns Following I/B/E/S Earnings Surprise”, Journal of Accounting Research, 44 (5) Elgers, P., M. Lo, and R. Pfeiffer,J r, 2001, “Delayed security price adjustment to financial analysts' forecasts of annual earnings”, The Accounting Review, 76 (4): 613-632. Gleason, C., and C. Lee, 2003, “Analyst forecast revisions and market price discovery”, The Accounting Review, 78 (1): 193-225. Mikhail, Walther, Lewis, 1999, “Does Forecast Accuracy Matter to Security Analysts?”,The Accounting Review, Vol. 74( 2), pp. 185-200 Sinha, Brown, Das, 1997, “A Re-Examination of Financial Analysts’ Differential Earnings Forecast Accuracy”, Contemporary Accounting Research; 14, 1;

25. 25SystematIQ Research| Capital IQ, A Standard & Poor’s Business Interesting Stats – US: FY1

26. 26SystematIQ Research| Capital IQ, A Standard & Poor’s Business Interesting Stats – Intl: FY1