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Star status among financial analysts overrated, new study says

4/10/2008

Louis Chan
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Photo by L. Brian Stauffer
Finance professor Louis Chan says star status among financial analysts is overrated.

Jan Dennis, Business & Law Editor
217-333-0568; jdennis@illinois.edu

CHAMPAIGN, Ill. —
Some Wall Street analysts are hailed as stars, packing enough wallop to send stock prices soaring or tumbling as their earnings forecasts ripple through a growing landscape of financial news outlets.

But while some analysts crunch numbers better than others, the gap is small and ultimately doesn’t give investors as much of an edge as Wall Street brokerage firms lead them to believe, according to a new study co-written by three University of Illinois business professors.

“The margin of superiority between the best and the worst analysts wasn’t really anything to write home about, less than 1 cent per share on average. If investors were to just follow the stars’ forecasts, it’s not like they’re going to get rich,” said Louis K.C. Chan, a U. of I. finance professor and lead researcher for the study.

“I think the findings tell the investor that maybe you shouldn’t pay too much attention to these star analyst forecasts,” he said. “In a sense, maybe it’s more of a publicity game. There’s a publicity machine that’s oriented toward selling investment services, so it tends to exaggerate any differences.”

The study, which will appear in the Journal of Investment Management, tracked annual corporate earnings forecasts by more than 13,000 analysts over nearly two decades, from 1984 through 2002.

Chan says the study identified several traits that make some analysts better forecasters, though the findings offered no real surprises and don’t explain the celebrity status that some analysts have attained in the media and among investors.

“To tell you the truth, it was a little disappointing that there were not larger statistical differences between the star analysts and the run-of-the-mill analysts,” Chan said.

“We had expected to find more proof for the inordinate amount of attention that these star analysts seem to receive.”

Veteran analysts are more accurate than novices, according to the study, “Are Analysts All Alike: Identifying Earnings Forecasting Ability.” The study was co-written by U. of I. finance professors Josef Lakonishok and David Ikenberry, the chair of the university’s finance department, and Sangwoo Lee, a finance and economics professor at the City University of Hong Kong.

The study also found that forecasts improve when analysts have fewer companies to monitor, update projections as new information surfaces and work for larger brokerage houses.

“Analysts with the big-name firms have more resources they can call upon,” Chan said. “They have more help crunching numbers, following news stories and industry trends. And if an analyst from Goldman Sachs calls the CEO of a company, the CEO is probably going to take that call. Analysts from smaller firms might just get passed off.”

Chan hopes the findings encourage investors to do their own homework, checking companies’ history and outlook closely as they consider stocks rather than relying on analysts who have become familiar names and faces in the business media.

“People are hungry for information, so they tend to latch onto these big names,” Chan said. “But there’s a danger that they may be overestimating how much these people know and following too blindly.”

“They should be aware that Wall Street analysts are not in the business of helping them make good investment decisions,” he said. “They’re in the business of selling stocks.”

Editor’s note:  To contact finance professor Louis K.C. Chan, call 217-333-6391; e-mail: l-chan2@illinois.edu.