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Will EPS growth estimates be revised downwards?
Mar 27, 2014

Investors in stock markets thrive on optimism. Hence, sell side firms typically come with an optimistic mindset. However, in order to make money in stock markets you have to be realistic and not optimistic. Nonetheless, let's take the case of optimism forward and see what happens when undue optimism on street meets reality. Many of us would be aware that most firms typically come out with earnings growth forecast of indices at the beginning of the year. However, as can be seen in today's chart, the earnings forecast inevitably stand reduced towards the end of the year. As an example, the median earnings growth forecast for India at the beginning of the year since 2001 has been 16.8%. But by the time the year comes to an end the median forecast drops to 14%. This does not just take place in India but happens in other countries as well. The change in estimates in Korea, Brazil, and other emerging markets can be seen in the chart.

Data Source: Mint * - Median since 2001; GEM - Global emerging markets;
AEJ - Asia ex-Japan; EMA - Emerging markets Asia; Indo. - Indonesia; Rus. - Russia

This trend as such indicates that most firms are overly optimistic on predicting earnings forecast of their respective indices at the start of each year. And as the year progresses, they tend to tone down forecasts to more realistic levels. This reflects over optimism bias of firms predicting the earnings, which tends to increase the margin of error while investing. We feel that adopting a conservative approach and building in a worst case scenario while forecasting earnings is a better approach to follow.

This Chart Of The Day was published in The 5 Minute WrapUp - All you need are a few ten-baggers...

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