When the forecast is wrong

I have found that it’s often the events that we look forward to the least that turn out surprisingly well and that many events that we have looked forward to for a very long time often tend to disappoint us. 

At the beginning of 2018, there were great expectations and hopes that our local stock market would finally turn towards the positive side after the FTSE/JSE All Share Index delivered only a very average performance of 8% growth per year up to the end of December 2017. 

Of course, this growth was largely due Naspers’s* (27% p.a.) growth over the same period. 

With the reporting of companies’ annual results come high investor expectations, and the same connection applies to analysts’ consensus forecasts, but some analysts can miss the mark completely with their forecasts. 

With this in mind, I think it’s only appropriate that we look at why some analysts get it wrong, and also at the facts currently at our disposal.

Shares have a tendency to react very positively following a better-than-expected financial results report (reflecting earnings growth), but also to react very negatively when weaker-than-expected results are reported. 

In negative cases, investor sentiment can influence share prices to such an extent that it can cause a complete collapse, just as in 2008
It doesn’t seem to matter if a company’s financial results are better compared with the prior reporting period. 

Failure to reach forecasts may cause the share price to drop simply because the company didn’t quite live up to investors’ expectations. 

So clearly consensus forecasts are watched very closely, and they can play a significant role in short-term volatility in the market.

Although analysts are not fortune tellers, these types of surprise earnings can be seen as a benchmark for analysts’ faulty forecasts. 

Of course, there are analysts out there who deliver extremely accurate forecasts, but there will always be a few who are completely off-target. 

Some of the main reasons for missing the mark at times include:

1. It’s extremely difficult to make earnings forecasts. 

So many variables have to be considered that it is nearly impossible to deliver a completely accurate forecast. 

2. Analysts’ forecasts have a tendency to group closer together as time progresses, and the problem with that is that the ‘herd’ isn’t always moving in the right direction.

3. Being over-optimistic.

4. Companies that soften the blow when bad news is reported. 

This is mostly due to mastering techniques for brilliant press conferences and other related meetings. 

I’m sure that everyone is now aware of the fact that the market didn’t turn around in 2018, and that it actually performed negatively (-6% since the beginning of 2018 to the end of January 2019). 

Investors were left shocked and highly disappointed because we were all looking forward to good news. 

But what was the reason for all this negativity?

I created a table that shows us which companies on the FTSE/JSE Top40 either exceeded (green) or fell short of (red) analysts’ forecasts based on their latest reported annual results. 

All the red that showed up was a dead giveaway. 

Only 29% of companies managed to exceed expectations based on their latest annual financial results, and then there are still those who haven’t yet reported. 

Though those companies may be green on paper for now, more recent published trading statements indicate that they didn’t manage to live up to consensus expectations. 

Yes, I know these are historical figures and there’s nothing we can do about it now, but I will be keeping a very close eye on these surprise earnings for the next six months, because according to Thomson Reuters consensus forecasts, analysts expect shares (FTSE/JSE Top40 Index) to come to the party with a whopping 18% expected growth (excluding dividends) over the next 12 months. 

All we need now is for this table to show a lot more green and a lot less red. 

Don’t miss the party altogether just because you’re not looking forward to it. Hang in there. Market conditions may still be uncomfortable, but investors should also guard against aggressive selling.

Schalk Louw is a portfolio manager at PSG Wealth.

*finweek is a publication of Media24, a subsidiary of Naspers.

This article originally appeared in the 7 March edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.