Estimates or guesstimates?

Given that analysts in brokerages are saddled with 3-4 sectors, it is unlikely they will come up with correct predictions

Every quarter, sell-side analysts embark on an activity which is quite perplexing — making and disseminating ‘earnings estimates’. Every brokerage house releases such estimates for many large-cap companies (and a few small ones, too). There are a couple of points common across all quarters:

* Clustering: It is remarkable that there is hardly any difference in the estimates made prior to the results, irrespective of whether it is a globally reputed brokerage house or a small one. One would guess that the larger ones base their estimates on the figures given out by the managements during ‘closed-door’ meetings, as well as the periodic ‘guidance’ given by them. The smaller ones simply piggyback on the larger brokers’ estimates and pass these off as their own. In either case, there is not much analysis involved.

* Variance: Often, there is a significant variance between estimates and actual figures. Sometimes, even the direction of the actual results is not the same as estimated. So much so, that in the US, there is an indicator known as the “Earnings Surprise Indicator” which measures the variance of the variance. Confused…Well, you are not the only one.

The whole exercise, in many cases, is quite absurd. For good reason, too. At most brokerage firms, each analyst tracks three to four sectors. Now, each of these will have a couple of humungous companies/conglomerates involved in a diverse range of activities. Given the number of moving parts, I think even the managements of these companies know it is futile to indulge in quarterly predictions.

However, the analyst at the brokerage house, (often multi-tasking and not an industry specialist) apparently seems to be doing what the top management of the company dare not, that is, give precise predictions.

I also wonder who really tracks and believes these estimates. Seasoned investors might not even look at these, as they have proved to be wrong on too many occasions. Maybe there is a case for these reports because the media laps it up to predict the results before and, then, compares it with the final numbers.

What is good to see is that many companies are desisting from providing quarterly guidance, as they believe this practice encourages short-term speculation on stocks.

If this trend gathers momentum, then, maybe, analysts will have to begin analysing and not merely reporting.