Devoted to understanding the basics and fundamentals of investing

In a previous post I wrote about Zacks, a company that uses analyst reports to build a consensus forecast for companies and then parses the companies into those with rising estimated earnings to those with falling estimated earnings.  They assign a ranking to each of these companies and the methodology appears to add alpha.

Today I will discuss a company that also looks at analyst forecasts of earnings.  StarMine differs from Zacks.  StarMine makes analysts accountable for their earnings forecasts.  StarMine objectively measures analysts on both the estimate accuracy and recommendation performance.  StarMine uses the results to generate analyst rankings from 1-star to 5-star (best).

The current ranking is predictive of future ranking.  For earnings estimates, a 5-star analyst is 3 times more likely to remain in the top quintile than to fall to a 1-star ranking.  For their stock picking recommendations, a 5-star analyst are over 50% more likely to remain in the top third of all analysts from one year to the next than they are to fall to the bottom third.  StarMine reports that the 5-star analysts' portfolios return 14% more per year than the 1-star analysts.
In a consensus forecast each analyst's forecast is given equal weight.  StarMine factors in the timeliness, historical accuracy, and some other factors to produce a "SmartEstimate."  When the SmartEstimate differs by more than 2% from the consensus forecast, it has a 75% success rate in predicting earnings surprises.  The Zacks' research showed that earnings surprises produce outperforming stocks.

For example, from July 1994 to December 2000 an equal weighted portfolio of Russell 3000 stocks produced an annualized return of 14.8%.  "A basic SmartEstimate strategy that chose to buy stocks that rank in the top quintile of both predicted surprise and recent earnings revisions yielded 50.5%."  The bottom quintile yielded just 4.4%

"Earnings revision models have profitable captured a market anomaly that has persisted for decades.  The anomaly has worked well because earnings revisions have been highly correlated to future revisions, which in turn have been highly correlated to future moves in stock prices."

StarMine has many other tools for investors to use beyond the scope of this post.  You can find them at www.starmine.com and they offer a free trial.  I use their service every day.

The quotes and the statistical reporting all come from the StarMine web site.