Buy-side vs. sell-side analysts’ earnings forecasts.

QUESTION:

Problem 86E

Buy-side vs. sell-side analysts’ earnings forecasts. Financial analysts are hired by investment companies to make forecasts of stock prices and recommendations about whether to buy, sell, or hold specific securities. These analysts can be categorized as either “buy-side” analysts or “sell-side” analysts based on a variety of factors, including scope of industry coverage, sources of information used, and target audience. A group of Harvard Business School professors compared earnings forecasts of buy-side and sell-side analysts (Financial Analysts Journal, Jul/Aug 2008). Data were collected on 3,526 forecasts made by buy-side analysts and 58,562 forecasts made by sell-side analysts, and the relative absolute forecast error was determined for each.

a. Frequency distributions for buy-side and sell-side analysts forecast errors (with the sell-side distribution superimposed over the buy-side distribution) are shown in the accompanying figure. Based on the figure, the researchers concluded “that absolute forecast errors for buy-side analysts have a higher mean and variance than those for the sell-side analysts.” Do you agree? Explain.

b. The mean and standard deviation of forecast errors for both buy-side and sell-side analysts are given in the following table. For each type of analyst, provide an interval that will contain approximately 95% of the forecast errors. Compare these intervals. Which type of analyst is likely to have a relative forecast error of +2.00 or higher?

Source: Based on Groysberg, B., Healy, P., & Chapman, C. Financial Analysis Journal, Vol. 64, No. 4. Jul/Aug. 2008 (Table 2).