Analyst Irrationality and the Impact of Implicit Beliefs on Consensus Earnings Forecasts

Abstract

A large and varied literature exists on the systematic biases in security analysts' earnings forecasts. While previous research has studied how analysts weight public versus private information when formulating earnings projections, the issue of how these forecasters weight information about different aspects of pro tability has remained entirely unexamined. This study seeks to fill this gap in the literature by examining security analysts' weighting of information regarding profit margin and revenue. I show that analysts overweight their implicit forecasts of both margin and sales when forming their earnings projections, causing their earnings forecasts to be oversensitive to their underlying beliefs. Furthermore, I find that the magnitudes of these weights are generally greater for longer-term and negativevalued forecasts. Finally, I show that the weights that forecasters assign to their implicit beliefs depend upon the market capitalization and leverage of the firm whose earnings they are forecasting.