McKinsey Study Confirms Sellside Analysts Are Conflicted, Slow, Biased And Generally Stupid

In what will come as a surprise to precisely nobody, a new study by McKinsey has confirmed that sellside analysts were "typically overoptimistic, slow to revise their forecasts to reflect new economic conditions, and prone to making increasingly inaccurate forecasts when economic growth declined." In other words, as V.I. Ulyanov may wall have said, useless idiots, had he lived in a time when Tesla was being pitched to him at a N/M PE multiple. One only needs to recall AJ Cohen's bold (and slightly more than idiotic) 2007 prediction for an S&P at 1,675 (dot 11235813*) in 2008, when the market closed at least than half that number, to see just how utterly worthless these people and their garbage predictions truly are. Yet day after day they serve as content filler inbetween ads on CNBC, as they sucker whatever remaining viewers the propaganda organization has left into one failed investment idea after another.

Yet for those who still don't realize that the only thing sellsiders are useful for is datamining and creating pretty charts, here is some more data from McKinsey, confirming the uselessness of the sell side, and validating that sellsiders tend to be consistently off the mark...

A recently completed update of our work only reinforces this view—despite a series of rules and regulations, dating to the last decade, that were intended to improve the quality of the analysts’ long-term earnings forecasts, restore investor confidence in them, and prevent conflicts of interest.2 For executives, many of whom go to great lengths to satisfy Wall Street’s expectations in their financial reporting and long-term strategic moves, this is a cautionary tale worth remembering.

Exceptions to the long pattern of excessively optimistic forecasts are rare, as a progression of consensus earnings estimates for the S&P 500 shows (Exhibit 1). Only in years such as 2003 to 2006, when strong economic growth generated actual earnings that caught up with earlier predictions, do forecasts actually hit the mark. This pattern confirms our earlier findings that analysts typically lag behind events in revising their forecasts to reflect new economic conditions. When economic growth accelerates, the size of the forecast error declines; when economic growth slows, it increases.3 So as economic growth cycles up and down, the actual earnings S&P 500 companies report occasionally coincide with the analysts’ forecasts, as they did, for example, in 1988, from 1994 to 1997, and from 2003 to 2006.

they are Overoptimistic...

Moreover, analysts have been persistently overoptimistic for the past 25 years, with estimates ranging from 10 to 12 percent a year,4 compared with actual earnings growth of 6 percent.5 Over this time frame, actual earnings growth surpassed forecasts in only two instances, both during the earnings recovery following a recession (Exhibit 2). On average, analysts’ forecasts have been almost 100 percent too high.6

And completely dislocated from the actual market...

Capital markets, on the other hand, are notably less giddy in their predictions. Except during the market bubble of 1999–2001, actual price-to-earnings ratios have been 25 percent lower than implied P/E ratios based on analyst forecasts (Exhibit 3). What’s more, an actual forward P/E ratio7 of the S&P 500 as of November 11, 2009—14—is consistent with long-term earnings growth of 5 percent.8 This assessment is more reasonable, considering that long-term earnings growth for the market as a whole is unlikely to differ significantly from growth in GDP,9 as prior McKinsey research has shown.10 Executives, as the evidence indicates, ought to base their strategic decisions on what they see happening in their industries rather than respond to the pressures of forecasts, since even the market doesn’t expect them to do so.

In other words, if you need a lemming to type up an unoriginal, groupthink report, most certainly call up the highest rated II analyst one can find. For any other actually productive and valuable work, please avoid sell side analysts like the plague (airborne and highly virulent edition).