Analysts’ earnings estimates did not become more accurate following the increased regulation put into effect in the last decade. Though there was a short-term improvement, the long-term trends show a decrease in accuracy and an increased dispersion among individual earnings estimates for a given company. This is the finding of a study to be published in a forthcoming issue of the Financial Analysts Journal.

In response to accounting scandals and securities law violations during and following the tech bubble, several rules and regulations were implemented. They included Regulation Fair Disclosure (FD) in August 2000 as well as the Sarbanes-Oxley Act (SOX), U.S. exchange rules separating research analysts and investment bankers, and the Global Analyst Research Settlement (GARS) in 2002. Combined, these laws, rules and regulations were intended to ensure all parties have equal access to the release of material information, improve corporate governance and reduce conflicts of interests between analysts and the companies they cover.

The study’s authors looked at I/B/E/S earnings estimates for the period of 1994 through 2013. The lengthy time frame was used to determine the level of accuracy and the amount of dispersion (agreement) among analysts’ forecasts prior to and after the new rules were implemented.

The median forecast error (incorrect earnings projection) increased during the pre-regulation period of 1994–2000, decreased slightly by the end of the short-term post-regulation period of 2003 through 2006, and then increased to back to near pre-regulation levels by the end of the long-term post-regulation period of 2007–2013. The median forecast dispersion (how different earnings forecasts are) generally decreased during the pre-regulation period, trended downward only to increase slightly by the end of the short-term post-regulation period and continued to increase during the long-term post-regulation period. Dispersion was higher at the end of 2013 than it was prior to 2000.

The authors summarized their findings by saying, “Overall, our results show that analyst forecast accuracy and dispersion have deteriorated significantly in the long run despite all the regulations.” They added, “These results imply declining transparency contrary to our expectation. We conclude, therefore, that these regulations did not collectively improve the information environment in the long term, despite the reduction in analyst conflicts of interest. The continued problem with the information environment, therefore, seems to be due to the quality of financial reports.”

We’ll add that while analysts’ forecasts can be inaccurate, there is value in the direction and magnitude in which the consensus earnings estimate changes. The AAII Estimates Revisions Up and Estimates Revisions Down strategies have among the best and worst returns, respectively, of all AAII stock screens. So, while the actual forecasts may be not be accurate, the direction in which the consensus forecast changes can be a driver of stock price movement.

Source: “Did Analyst Forecast Accuracy and Dispersion Improve Following the Increases in Regulation Post 2002?” Hassan Espahbodi, Pouran Espahbodi and Reza Espahbodi; Financial Analysts Journal (forthcoming).