Abstract--Further Evidence on the Random Nature of the Errors Associated with Corporate Earnings Forecasts

Abstract

FURTHER EVIDENCE ON THE RANDOM NATURE OF THE ERRORS ASSOCIATED WITH CORPORATE EARNINGS FORECASTS R. Malcolm Richards and Donald R. Fraser* Previous research suggests that earnings growth rates are random in nature such that reliable earnings projections cannot be made based solely on the earnings time series. The purpose of this study was to determine whether earnings forecasts made by security analysts remain a random variable when the information set is expanded to include publicly available information about firms whose earnings are being projected. This was accomplished by relating firm financial variables to the forecast errors resulting from corporate earnings forecasts. Forecasts of 1973 earnings for 100 large corporations were accumulated from the in? vestment reports of banks, brokerage houses, and investment advisory services. These forecasts were compared to actual earnings figures and a mean forecast error was computed. Twenty-four variables (measuring financial leverage, operating leverage, and other finan? cial aspects of the firm) were then related to the forecast errors through the use of simple correlation coefficients, principal component analysis, and multiple regression. The results of the research are, in general, quite consistent with previous re? search. Knowledge of the specified characteristics of the firm did not permit full explanation of the forecast errors. Such errors appear to be random in nature and not readily explainable by characteristics of the firm. This does not mean that earnings do not follow a trend, but rather that movements about the trend line are random in nature. The only variable found consistently to be related to the forecast error was the growth rate of sales. Texas ASM University.