The Other McCain

"One should either write ruthlessly what one believes to be the truth, or else shut up." — Arthur Koestler

Optimism, Inc.

Posted on | June 14, 2010 | 4 Comments

Wall Street analysts consistently overestimate the profit potential of companies:

Some economists look at the global economy and see troubles — the European debt crisis, persistently high unemployment worldwide, and housing woes in the U.S. Stock analysts as a group seem unfazed. . . .
Caterpillar, a multinational that gets much of its revenue abroad, is expected to boost its net income by 47 percent this year. Analysts have also hiked their S&P 500 profit estimate for 2011 to $95.53 a share, up from $92.45 at the beginning of January, according to Bloomberg data. That would be a record, surpassing the previous high reached in 2007. . . .
If the analysts are correct, the market would appear to be attractively priced right now. . . .
If history is any guide, chances are good that the analysts are wrong. According to a recent McKinsey report by Marc Goedhart, Rishi Raj, and Abhishek Saxena, “Analysts have been persistently over-optimistic for 25 years,” a stretch that saw them peg earnings growth at 10 percent to 12 percent a year when the actual number was ultimately 6 percent. “On average,” the researchers note, “analysts’ forecasts have been almost 100 percent too high,” even after regulations were enacted to weed out conflicts and improve the rigor of their calculations. . . . [I]n most years analysts have been forced to lower their estimates after it became apparent they had set them too high. . . .

Read the whole thing. The problem with “rosy scenario” forecasts is the gap between exoteric and esoteric knowledge.

It’s like Enron executives who were steadily cashing in their stock options even while they were telling the world and their own employees that everything was just fine, as the company teetered on the brink of collapse. The executives had esoteric knowledge, known only to a handful of insiders, which was obviously much different than the exoteric knowledge available to outsiders.

Think about this in terms of the “jobless recovery.” We are told that various indices show the U.S. economy is experiencing real growth and yet the employment rate remains high — officially 9.7% in May.

Why aren’t companies hiring? Could it be the gap between esoteric and exoteric knowledge? The executives and managers who the decisions that affect hiring at companies know how much money is available to meet payroll. If businesses are not hiring, despite all the economic “good news” being touted to the public, could it be that they know something that the analysts don’t?

Category: Economics

Comments

4 Responses to “Optimism, Inc.”

  1. Barack Obama
    June 14th, 2010 @ 11:35 am

    Stacy, Are you saying Glenn Beck is right?

  2. Barack Obama
    June 14th, 2010 @ 7:35 am

    Stacy, Are you saying Glenn Beck is right?

  3. Estragon
    June 14th, 2010 @ 8:29 pm

    Naturally analysts are always over-optimistic.

    In order to do their jobs, they not only pour over public records, but they need access to the latest information affecting the companies they cover. To get this, they need open doors at those companies and their competitors, good relations provide more candid guidance and a generally more pleasant atmosphere.

    The tendency is therefore to overestimate the value and future earnings. It’s not that they don’t try to be accurate; it is just that they will always err on the up side. This tendency would be self-correcting if the market rewarded analysts who were closer to accurate over time, but it has not.

    One note: Enron – or any other executives – should not be criticized for “cashing in their stock options” because this was part of their income. Remember, there was a huge hissy-fit by the leftists about million-dollar CEO salaries and the government responded by encouraging (through the tax code) companies to compensate execs with more stock options and less cash, so as to tie income to company performance. If a stock option isn’t exercised, it expires and is worthless.

    Of all the sins of Enron, execs cashing in their options was not one of them.

  4. Estragon
    June 14th, 2010 @ 4:29 pm

    Naturally analysts are always over-optimistic.

    In order to do their jobs, they not only pour over public records, but they need access to the latest information affecting the companies they cover. To get this, they need open doors at those companies and their competitors, good relations provide more candid guidance and a generally more pleasant atmosphere.

    The tendency is therefore to overestimate the value and future earnings. It’s not that they don’t try to be accurate; it is just that they will always err on the up side. This tendency would be self-correcting if the market rewarded analysts who were closer to accurate over time, but it has not.

    One note: Enron – or any other executives – should not be criticized for “cashing in their stock options” because this was part of their income. Remember, there was a huge hissy-fit by the leftists about million-dollar CEO salaries and the government responded by encouraging (through the tax code) companies to compensate execs with more stock options and less cash, so as to tie income to company performance. If a stock option isn’t exercised, it expires and is worthless.

    Of all the sins of Enron, execs cashing in their options was not one of them.