When Consensus Earnings Forecast and Stock Return Diverge
December 19, 2014 - Fundamental Valuation, Investing Expertise
Do changes in consensus analyst earnings forecasts that disagree with contemporaneous stock returns signal exploitable mispricings? In their November 2014 paper entitled “To Follow or Not to Follow – An Analysis of the Profitability of Portfolio Strategies Based on Analyst Consensus EPS Forecasts”, Rainer Baule and Hannes Wilke investigate the power of a variable that relates consensus earnings forecast momentum to stock price momentum to predict stock returns. Specifically, the variable is the ratio of (1+change in consensus earnings forecast) to (1+stock return) over the last six months. Their consensus earnings forecast metric is a rolling average of consensus estimates for the current and next years weighted according to proximity of the current-year forecast to the end of the firm’s fiscal year (for example, three months before the end of the fiscal year, the rolling 12-month metric is 3/12 of the forecast for the current year plus 9/12 of the forecast for next year). They measure predictive power via a portfolio that is each month long (short) the fifth of stocks with the highest (lowest) last-month variable values. They evaluate both raw excess portfolio performance (relative to the risk-free rate) and four-factor portfolio alpha (adjusting for market, size, book-to-market and momentum factors). They limit the stock universe to the widely covered and very liquid components of the S&P 100 Index. Using monthly analyst consensus earnings forecasts and total returns for S&P 100 stocks during February 1978 through December 2013 (a total of 278 stocks listed for at least one month), they find that: Keep Reading