ANALYSTS’ FORECASTS There are many financial services firms offering projections on different

ANALYSTS’ FORECASTS There are many financial services firms offering projections on different

aspects of a firm’s performance. The most common financial ratio fore- cast is future earnings per share of a firm, though projections of cash flows and stock prices are available. For most companies whose stock is publicly traded, there are a number of analysts who analyze the stock and make forecasts regarding earnings in the future.

In addition to the forecasts made by individual analysts, several ser- vice providers collect and report statistics of analysts’ forecasts. Several of these service providers are identified in Exhibit 23.4. One of the most common statistics is the consensus earnings forecast. The consensus earnings forecast is the average of the earnings per share forecasts for a

10 American Express 1997 Annual Report, “Consolidated Highlights.”

FINANCIAL STATEMENT ANALYSIS

given loose stock. 11 Services that provide analyst forecast information also provide earnings surprise analysis—the difference between actual earnings per share and the forecasted earnings per share, where the con- sensus forecast is used as the forecasted earnings per share.

EXHIBIT 23.3 Microsoft’s Basic and Diluted Earnings Per Share, 1985–2002

Source: Earnings per share data from Microsoft’s Investor Relations web site, www.microsoft.com/msft/ar98/fins.htm

EXHIBIT 23.4 Analyst Forecast Service Provider

Service Provider Address

First Call www.firstcall.com Institutional Brokers Estimate System (I/B/E/S)

www.ibes.com Multex

www.multexnet.com Zacks Investment Research *

www.zacks.com * Zacks’ analysts’ forecast information is available through other sites, including Ya-

hoo! Finance [biz.yahoo.com/zacks/] 11 Though the average of forecasts is typically used to represent the consensus fore-

cast, the distribution of analysts’ forecasts may not be normal (that is, symmetric and centered on the average). Further, the range in forecasts may be large. For example, the distribution of Zacks’ reported 1999 forecasts for Disney has an average of $1.06, ranging from $0.95 to $1.25.

Earnings Analysis

There are three issues related to using analysts forecasts in investment analysis. First, different providers define actual and forecasted earnings differently. There are different earnings per share amounts historically (simple, primary, and fully-diluted) and currently (basic and diluted) and different analysts will forecast for different earnings per share.

Second, analysts’ forecasts are made at different points in time. Not all analysts sit down at the same time to make forecasts, so consensus forecasts are an average of forecasts made at different point in time. Because we know that analysts’ forecasts are more accurate as the time approaches to release actual earnings, this means that a set of forecasts at

a point in time is a collection of forecasts that have different degrees of accuracy. Finally, there are differing degrees of analyst following. There are some companies for which few analysts make forecasts, whereas other companies have many analysts following. An earnings surprise in a company for which there are few analysts following it may have a dif- ferent stock market reaction as compared to a surprise of similar magni- tude for a well-followed company. For example, there are 26 analysts reporting forecasts to Zacks Investment Research for the 1998 fiscal year for Walt Disney Company, compared to four analysts for OEA Inc.

Consensus earnings forecasts and the forecasts of individual ana- lysts are used to compute several measures that researchers have found to be important factors in explaining stock returns. The first measure is earnings momentum. This is a measure of consensus earnings growth found by computing the growth in earnings based on actual earnings for the current period and the consensus earnings forecasts for the next period. Some analysts and services refer to this as earnings torpedo. A second measure is the number of analysts that have increased their esti- mate of earnings less the number that have decreased their estimate of earnings, divided by the total number of analysts who have provided estimates. A variant of this measure is the percentage of analysts who have revised upwards their earnings estimate for the next period.