Analysts’ Collective Bullishness: A Return to Normal?

It was just two weeks ago that we blogged about an interesting study done by McKinsey & Co. discussing the overly bullish track record of the Wall Street analyst community dating back decades (The Analysts’ Horrendous Track Record Exposed).  In that brief piece we noted that the analysts have–as a whole–underestimated rebounding corporate profits over the last year, but we expected that trend to revert to the more historically normal trend of overestimation of corporate earnings growth.  It seems it did not take long for the bullishness to return to the Wall Street analysts, as an article on says it all.

“Estimates for companies in the S&P 500 show profits may jump 19 percent in 2010, the most since 1995, and 18 percent in 2011, according to data compiled by Bloomberg. The index trades for 13.4 times 2010 per-share earnings forecasts, compared with an average multiple of 16.4 times reported income since 1954.

Highest Since 2008

Should analysts’ forecasts for a 25 percent gain in the S&P 500 come true, the gauge would climb to 1,361 by next May, the highest level since June 2008.” – 6/1/2010

The 25% or more gains for the S&P 500 are based on an accumulation of estimates by more than 2,000 analysts tracked by Bloomberg.  This consensus forecast shows that rightly or wrongly bullishness is alive and well in equity research despite the recent global tumult.  We have been as impressed as anyone by the strength in corporate earnings performance, but we also have to recognize this was enabled by widespread cost cutting during the recession.  While payrolls have been slashed and inventories remain lean, top line growth has been more subdued.  Revenue growth is an important gauge of health of a company, as it clearly less manipulated by accounting chicanery than is profit.

To be clear, we are not here to judge the earnings growth projections of analysts; rather we think it is interesting to note this trend of bullishness.  It is as yet unaffected by European sovereign debt concerns, leaking oil in the Gulf, terrible equity performance in May or anything else.  In general, we tend to agree with the assessment by McKinsey that the analysts are too optimistic about the companies they cover, but that doesn’t mean stocks are overvalued or that earnings won’t grow impressively in the years ahead.

Did they get it right this time or is this just more of the same old song and dance?  One thing we know for sure, the bar has been raised and companies will soon discover it is tougher to “beat the Street”.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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