What Factors Drive Analyst Forecasts?

Using survey data to judge how analyst forecasts are related to evaluations of companies’ industry competitiveness, strategic choices, and internal capabilities, the authors found that analyst forecasts are associated with many of the factors that money managers rate as important in their assessments of analyst contributions. They also found wide variation in ratings consistency across variables among analysts covering the same company. On average, consistency is higher for sell-side analysts than for buy-side analysts. Although extensive research has been conducted on analysts’ earnings forecasts and recommendations, relatively little has been written about the factors that underlie them. In our study, we examined which industry, leadership, and company factors are related to analysts’ forecasts of financial and stock performance. We also examined whether analysts covering the same company make consistent assessments of its industry, leadership, and company capabilities.To study these questions, we used data from a survey of 967 analysts who rated 837 companies on their projected future performance, industry economics, company capabilities, and leadership. Analysts were asked to provide forecasts of growth in revenues, earnings, and stock price, as well as gross margins, for up to three companies they covered. For each company, they were also asked to rate industry, company, and leadership factors that prior research suggests influence future performance. These factors include the competitiveness and growth of each company’s industry, whether it competes primarily on the basis of innovation or price, its strategy execution and communication, its innovativeness, existing financial resources, the quality of its top management, whether management sets high performance standards, and its governance.We found a strong relationship between analysts’ forecasts of a company’s performance and their assessments of its industry growth, industry competition, quality of its management, commitment to high performance expectations, ability to execute strategy, and innovation. We found that several factors are generally unimportant, including governance, transparent strategy communication (especially for buy-side analysts), competition via superior products/services, financial strength, and understanding one’s competitors.Considerable variation in ratings consistency exists across factors among analysts who cover the same company. Analyst ratings are relatively more consistent for company revenue forecasts, balance sheet strength, strategy execution, and strategy communication than for industry competitiveness, forecasted stock appreciation, low-price strategy, and understanding one’s competitors. Consistency is significantly higher for sell-side analysts than for their buy-side peers, perhaps reflecting sell-side pressure to herd. Finally, we found no evidence that analysts are more consistent on financial forecast factors than on internal capability factors.