2014 Faculty Perspective on the Success of Wall Street Analysts

January 31, 2014  | 1 min read

On Tuesday, December 31st, the Dow Jones Industrial Average (DJIA) closed the year at a record high 16,577. This milestone is remarkable considering five years earlier the DJIA was at roughly half that level and would not bottom out for another six months. In the recent DJIA run up, those who invested placed tremendous attention and financial stake in the opinions of analysts. This was evidenced by interest from the investment community and financial media in the selection of “All Star” analysts and their continued reliance on analyst rankings. However, says Dr. Andreas Simon, an assistant professor of accounting at Pepperdine University who studies the predictive success of Wall Street analysts, many investors do not know the degree to which an analyst’s results are a function of skill and how much should be attributed to plain luck. Dr. Simon believes that it is possible to identify ex ante Wall Street analysts who are truly skilled and not just lucky. To do so, investors must understand the decision-making process that analysts use. In a forthcoming paper, to be published in peer-reviewed Applied Financial Economics, Dr. Simon identifies numerical measures that can serve as a proxy for dissecting financial analysis performance. Specifically, Dr. Simon’s research proposes a measure of relative forecast accuracy over time controlling for forecasting complexity. Analysts that are more persistent in relative forecast accuracy, after controlling for forecasting complexity, have a better understanding of industries and a company’s future prospects. This effort is reflected in the profitability of their stock recommendations. Dr. Simon concludes that over longer periods of time skill has a much better chance of shining through.