When Charlatans Believe Their Own Hype

Just like sports reporters, stock analysts' primary job isn’t prediction, it's narration. Much of the finance industry exists as entertainment for the elite who wouldn’t do anything lowbrow like pay attention to sports. The endless analysis of trades, players, speculations and “new” tactics serves the same purpose in sports and finance – it’s solely entertainment.

There is a large amount of data supporting the fact that analysts are literally no better than the man on the street at predicting stock prices or earnings.

This quote is from the Mr. Random Walk himself, Burton Malkiel:

Security analysts have enormous difficulty in performing their basic function of forecasting earnings prospects for the companies they follow. . . . Bluntly stated, the careful estimates of security analysts (based on industry studies, plant visits, etc.) do very little better than those that would be obtained by simple extrapolation of past trends. . .

The same argument with more mathematical rigor was made by studying 80,000 analysts forecasts over a period of 20 years,

The odds are staggering against the investor who relies on fine-tuned earnings estimates. They estimate there is only a 1 in 170 chance that the analysts' consensus forecast will be within 5% for any 4 consecutive quarters.

Analysts estimates are better a predicting other analysts’ estimates than anything else. Indeed, an analyst of any skill would move to the bigger paychecks of the hedge fund world as soon as possible.

In order to keep up the illusion of skill the analysts go through an elaborate show which typically includes; talking with management, visiting plants, and constructing exceedingly intricate models. When their forecasts are close, they can take the credit since their hard work apparently paid off. When they inevitably fumble – well…no one else got it right either.

When one of the analysts threatens to lift the curtain on the whole scheme the charlatans panic and start their denouncements. What makes this story so entertaining is that the criticism is not based on the analysis – only the method, knowing full well its makes no difference.

A Wall Street analyst has raised eyebrows among competitors and customers because he did not speak to the senior management he wrote about prior to launching coverage of seven well-known pharmaceutical companies.

For decades, when compiling their initial reports, analysts have traditionally met with corporate management, such as the chief executive, or at least the chief financial officer.

Currency Converter