In this post, Robert Davies, manager of the UK Smart Dividend UK Fund, discusses the utility (or lack thereof) of professional stock market analysts.
Stock market analysts have a mixed reputation. The best of them know their industries better than some of the participants while the worst will simply parrot corporate press releases and, in effect, act as an extension of the investor relations department.
It is hard to say if the trend is towards the latter because ever-tighter rules on disclosure and what is and what is not inside information make truly original investment research harder.
In some sectors though you don’t need to be a genius to understand what is going on.
The most obvious is in the commodity industries of oil and mining. Terminal markets for oil, copper and now iron ore make it clear to everyone what is happening to revenue, and in a way that is simply not possible in more secretive businesses like banking or insurance.
Oil and metal prices started falling in the autumn of 2014 and carried on declining relentlessly throughout 2015. To be fair to the analysts, it is unlikely they were using the high spot prices of early 2014 in their models for longer-term forecasts. Yet at some point spot prices would have crossed over and fallen below those longer-term projections.
That was probably last summer when the Glencore share price halved. Investors finally got the message that Glencore’s business model of high-cost mines and a highly geared balance sheet were not a good mix in a world of lower prices and higher interest rates.
As is always the way, share prices reacted far more rapidly than analysts could change their forecasts, so the shares looked cheap for a long time, especially when allowance was made for the stronger dollar which was related to the other two factors.
The information void was not helped by companies, and by extension their spokespeople (the analysts), saying that things were not really that bad. But investors were in no mood to be trusting after so many cases of corporations, like Tesco and VW, attempting to reassure them with platitudes having already misled them.
Even now some analysts are forecasting that Anglo American will pay a dividend in 2016 when the company said in December it won’t. These analysts are probably just lazy rather than misguided.
However, there are serious questions over the viability of the dividends from big payers such as BHP Billiton and Shell which say their dividends will be held.
At the start of 2016, the consensus from all the analysts is that UK-listed companies will pay out £87 billion in dividends this year. But what happens if we assume that both Shell and BHP cut their dividends by, say, 50%?
In fact, it reduces the forecast pay-out to £81 billion. That is still a big number and still gives the market a prospective yield of 3.4% which is a lot better than most other asset classes.
So stock market analysts do have their uses; they do the heavy lifting of forecasting and give us an indication of what the consensus is for the future.
While that consensus is far more likely to be right than wrong, sometimes it isn’t, and no one tells you when that is, least of all the analysts, or the companies themselves.
I read that if an analyst is right 60% of the time its a good track record.
Andrew, I’d go one further and say if anybody was right 60% of the time they’d be making money. Being right less than 50% of the time, one would assume, means you are probably losing money.
Old chinese proverb!!! — just kidding.
Ah yes but it depends how right or wrong you are! You can be right just 10% of the time and come out ahead as long as the 10% of right decisions result in gains that outweigh the 90% of times when you’re wrong.
I do believe that all this exercise of forecasting next quarter and next year earnings is pointless. I just do not know why they are still doing it.
Obviously when the price of the commodity you sell halves, the earnings forecasted 3-6 months ago will not have any value.
However there are other things that an equity analyst could do to earn his keeping. There are things which could be seen in the accounts of the company and macro things which will create head winds or good winds for a company.