Why So Much Error in Analysts' Earnings Forecasts?

Wall Street analysts tend to be too optimistic about the earnings prospects of companies they follow. The average consensus 12-month EPS growth forecast is 17.7 percent, which is more than twice the actual growth rate. In aggregate, forecasts are 11.2 percent above actual earnings at the start of a year and are revised downward continuously in the course of the year. For the full study period reported here, the percentage of 12-month earnings estimates revised downward exceeded the percentage revised upward, on average, by 4.4 percent every month. Since 1993, however, the quality of analyst forecasts seems to have improved. This article provides an intuitive explanation of the change and suggests ways in which analysts can use the explanation to improve portfolio performance.