Stock Market Analyst Forecasts: add Salt and Pepper

The Salt
"Prediction is very difficult, especially if it's about the future."
-Nils Bohr, Nobel laureate in Physics, quote from University of Exeter

Analysts try to divine what the future will bring for companies or markets and then tell us whether to buy or sell. That it is exceedingly difficult to forecast accurately there is no doubt at all - people have checked by tracking and assessing analyst predictions. Analyst accuracy on average has been, and continues to be, very poor as discovered in such studies as, Forecast Accuracy of Individual Analysts: a Nine-Industry Study (MIT, 1987), The Bias of Wall Street Analysts (Harvard Business School, 2004), Equity Analysts: Still too Bullish (McKinsey Company, 2010). There is even a website - CXO Advisory Gurus - that continually tracks the accuracy of US analysts who have made publicly-available predictions. The top analyst manages only a 68% accuracy rate and two thirds of analysts failed to exceed 50% right, which isn't any better than random selection. Thus, the Salt advice - take analyst predictions about future market direction, individual stock prices, interest rates or any other financial data with a skeptical eye and a proverbial large grain of salt. They are most likely wrong. (It is well to remember that if you yourself start making predictions, then you become an analyst too!)

The Pepper
"It is far better to foresee even without certainty than not to foresee at all. "
Henri Poincaré in The Foundations of Science

Should one then simply ignore anything said or written by analysts? As the above quote suggests, there are reasons to consider analyst prognostications despite the high failure rate. Rather than trying to find the one or two "best" analysts who get it right, a fruitless task since success in one period more often than not becomes failure later on, here are some suggestions for a better approach to extract value:

• Consider analyst predictions as scenarios, or possible future outcomes. Particularly if there is disagreement between analysts, their discussion and explanation can bring out different factors to help form your own expectations of a high-low range and probabilities. A current example of divergent views is Jonathan Chevreau's Wealthy Boomer blog post Battling stock gurus on video: a bull, bear and superbear. If you cannot tell or don't want to chance which scenario will pan out, structure your portfolio to fare reasonably well regardless of which scenario comes to pass. Diversification through a variety of types of holdings (domestic and foreign equities, real return, government and corporate bonds, real estate, commodities including gold, cash) is the standard method to manage this challenge.
• Most analyst reports contain a very useful synopsis of key company business operations, financial ratios, comparative results and year-by-year trends, which saves the investor a lot of wading through quarterly / annual financial reports and number-crunching, enabling more time to be spent on the qualitative aspects of a company.

Our Pepper advice is thus to add flavour and taste to the plain investment fare of the raw numbers with a dash of opinion and judgement "pepper".

As with the culinary ingredients, one should be aware that there is always a limit to how much salt and pepper to add to produce a good meal and it is sometimes difficult to know how much is just the right amount.

Where to find analyst reports and opinions
Individual companies: A good place to start is the research section of the discount broker website where entering the company name or stock symbol will bring up links to one or more formal reports by research companies contracted by the broker.

Markets as a whole: Mainstream online media such as the Financial Post, GlobeInvestor, CNN Money, BNN, Yahoo Finance, Google Finance, Wall Street Journal, Bloomberg and Canoe Money also regularly feature less structured articles and video interviews of analysts and market gurus.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.