“There are two types of forecasters: those who don’t know,
and those who don’t know they don’t know”
John Kenneth Galbraith
Our internal research suggests that security prices and investment returns are greatly influenced by changing investor expectations… and that investor expectations are strongly influenced by earnings surprises reported by companies and estimate revisions made by Wall Street security analysts. Often, one earnings surprise is followed by another, and another, but investors seem “surprised” by each announcement.
In addition, Wall Street analysts do not behave in a manner consistent with the tenants of a completely efficient market. To the contrary, sell-side Wall Street analysts are influenced by a complex set of factors, ranging from the inherent difficulty of forecasting future profits, overconfidence, ego, availability bias, group think (including a desire to fit in their peer group), behavioral herding, concerns about reputation and compensation, pressure to maintain relationships with management teams, among other factors. Our models allow us to analyze the behavioral conditions of these analysts and find investment opportunities where analysts are making systematic errors in their earnings forecasts.