Why The Best Shares Often Have The Worst Looking Broker Forecasts

Tue 12:55pm by Edward Croft

8 comments 518 reads

In last month’s results season webinar, Graham and I discussed the surprising recent strength of UK contractors - names like Morgan Sindall (LON:MGNS) , Kier (LON:KIE) , and Galliford Try Holdings (LON:GFRD) - all of which have been quietly and consistently beating expectations for years.

These stocks have carried high, 90+ StockRanks throughout their multibagging runs, but I anticipate they may have been significantly under-owned by Stockopedia subscribers.

Why? Because whenever you looked at their StockReports in recent years, your eye would have been drawn to their earnings growth forecasts and those forecasts have almost always looked flat or uninspiring.

Everyone knows that earnings growth is a fundamental catalyst for share price acceleration. Jim Slater’s Zulu Principle taught us to look for high forecast earnings growth and moderate P/E ratios - growth at a reasonable price right? So, buying shares that show no forecast growth - or worse, negative growth - feels completely alien. Who wants to own a share without earnings growth?

But that’s exactly where the opportunity lies.

There’s far more power in the unexpected

I’ve been rattling on for much of the last year about the power of “ahead of expectations” announcements (see here, here and here). What really drives share prices isn’t forecast growth - it’s unexpected growth. Prices move the most when companies surprise to the upside - and brokers are forced to upgrade their numbers, which often leads to the P/E ratio expanding.

Let’s take Morgan Sindall (LON:MGNS) as a case study. Right now, brokers are predicting negative earnings growth over the next year. But, if you look at its track record, the company has repeatedly delivered significantly higher actual earnings growth than expected.

Go back in time through the last few years (using the rather handy “print” function on StockReports), and you’ll see the same story: earnings growth forecasts were low (less than 4% per year), but realised growth was strong (at nearly 17% annualised). The market was consistently surprised to the upside. It’s those earnings surprises - not the forecasts - that have powered the share price higher.

The StockRanks have long told the same story

This isn’t just a Morgan Sindall phenomenon. In a broader data study across a decade of UK market data using…

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OldSchool05

7:58am

So, should we be focusing on the Analyst Consensus box in the StockReport, as our best indicator of the movement in the trend of broker forecasts?

Such as below for Polar Capital Holdings (LON:POLR)

Epitychia

8:02am

Stock market trading is like playing three-dimensional chess.

Find a company that is making good profits…Maybe, but they probably already have a very high share price.

Find a company that will make higher profits next year…Maybe, but if they have a track record of growth, they probably already have a very high share price.

Find a company that will make higher profits next year, but no one expects this….Bingo.

cafcash49

8:06am

Thanks Ed, this is really interesting research. I have morphed into a Swing Trader and this will be very useful to look for high ranked stocks just before results are due. Info which is all available on Stockopedia. Hope this finds you well. Charles

rmillaree

8:30am

i tend to look at the historical trend on tocky ref eps forecasts. I want to concentrate much more on the direction of trending than anything else. There is a boatload of companies last 24 months that have started high this year and next and chipped away - ok that makes sense in tought times.

we are looking for companies doing well in tough times though - so i think the first time at present that company raises expectations (if trend has eitehr been flat or down) - is potentially the start of good times - the more that is backed up with no later reversal the better.

the most annoying ones are perhaps compaies that say they are on track - but trend has been soldily chipped away at all year - so they have really had a profit warning but done that in 3 6 or 9 chunks so its not a profit warning.

of the companies mentioned here two are eaxtly what i would want to see - eps estimates trending upwards nicely. Kier's is slightly more sketchy with blips - next year trending upwards but this year flat (downa rounding error) - Kier is on the cheaper rating though ref current p/e so that seems factored in. Note kier's range is very narrow so yes 22.4 eps is less than 22.6 12 months ago but thats pretty mucha roudning error.

all seems reasonably solid from al three companies with the lack of the nudges downwards that we see from many companies - note the nudges downward often include companies promising decent growth - for them the excuse that its tough is pretty poor - if you are promising growth much better to keep something in the tank just in case !

BattleOfBrit

9:07am

I've never found any correlation between broker forecasts and stock performance; I very rarely look at them; my performance improved dramatically when I started ignoring them and most of the news along with it.

Spender71

9:16am

Ed never rests in advancing our knowledge. All to great effect. Certainly I have been reluctant to invest in the quoted shares hitherto because of the poor forecasts.

Edward Croft

9:33am

OldSchool - yes.. the trend in forecasts is more predictive than the actual level of forecasts. That's why our Momentum Rank includes "earnings forecast upgrades", "recommendation upgrades" and "earnings surprises" as key factors... and why the StockRanks completely ignore the actual level of forecasts.

We knew this a long time ago when we created the StockRanks - but I'm still learning and feel like I'm still peeling back layers of the onion to deepen my own understanding. I do find that writing helps me gain understanding - as Richard Feynman said "if you want to master something, teach it" !

9:37am

M P Evans (LON:MPE) seems to be a current example of this phenonomen.

Why the best shares often have the worst looking broker forecasts

There’s far more power in the unexpected

The StockRanks have long told the same story

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Edward Croft

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