Accuracy of equity analysts report

Under the guidance of:

Prof. Parama Barai

Presented By: Sovan Nayak 11BM60077

Introduction
- In India every year lots of equity research reports

- are published giving recommendations about a particular stock - Contains a detailed description of the financial & operational performance of the company and the methodologies adopted by the analyst to arrive at the decision and finally a recommendation for the investor - A forecast of the firms future earnings, a target price and an investment recommendation - Generally the recommendations - buy, hold or neutral, sell are given by comparing the target price with the current market price

Problem formulation
- Each of the firm has its own way of research
and efforts and resources spend for a particular report - Access to information is also not uniformly available to all research firms though the information is public - External influences also have its role in distorting the research - Funding is different for different firms in the research. - All these create a fertile ground for conflicts of interest that can affect the quality and objective of the research

Major concerns
- The ability of analysts to offer a valuable service to their clients (i.e. investors) is a debatable topic. - Secondly, some of the research explored the ability of equity analysts to provide accurate forecasts. - Thirdly, the conflict of interests issue regarding the preparation of the reports was delved into.

Objectives of the study

To explore the ability of equity analysts to provide accurate forecasts To determine the accuracy of forecasting using accuracy metrics To determine the factors and their importance in forecasting To derive a model for forecasting

Review of Literature
Academic research so far has found three main factors influencing the behavior of financial analyst namely profitability issue, the accuracy issue and the conflict of interest issue Few observations: - Works have been done in exploring the informative nature of other parts of the report like the earnings forecast and recommendations (Francis and Soffer, 2003), the strengths of the analysts arguments and recommendation base (Asquith et al., 2005) and the target price. - A study conducted by Ljungqvist et al. (2007) found that analyst firms release are more accurate and less optimistic forecast when the covering stocks are largely owned by institutional investors

Review of Literature
Few have examined the correlation between the rating distribution of different analyst firms and the profitability of stock recommendations. A strong correlation has been seen between the accuracy of earning forecast and recommendations for profit. Most of the ongoing studies are designed to test the profitability of various trading strategies. The works that focused on the accuracy part compared and measured the ability of the analysts or the firms to forecast the target price by considering all possible drivers. A positive correlation has been found between the forecasted earnings accuracy and the reputation of the report publisher.

Methodology
Source of data collection: - Set of Analyst reports has been collected - BSE India - MoneyControl for balance sheet of companies Input: - The Target price, method used (DCF, multiples), recommendations(buy, sell, hold),current market price and the date of the report are collected. - The price after 1 year, the maximum and minimum price within the 1 year from the date of report and target date are noted. - From the balance sheet the PAT of last 3 years form the date of report, the volume traded in last 3 years and the geometric mean of the daily HPR on the stock for last 2 years of the date of report for the company is taken. - The beta of the company is taken - The growth rate of stock market is taken

Methodology
Accuracy of the target price The following methods are used: Binary metric - to distinguish between accurate forecasts and failed forecasts. - Percentage deviation of the actual price after 1 year from the target price Cardinal measure of the forecasting errors the forecasting error is usually measured by calculating the spread between the actual price at the end of the forecasting period and the forecasted price - Percentage deviation of the target price form the maximum price or the minimum price attained in the year between the report date and the target date -Percentage deviation of the actual price from the target price w.r.t. market price on the date of report

Methodology
The model
- the model can be used to determine the weightage of different factors contributing to the inaccurate forecast - to determine target price by giving the necessary inputs

Process:

Regression Model I Dependent variable: target price Independent variable: current market price, growth rate of sensex since 2006 till date of report, beta, PAT Y-1, PAT Y-2, Vol Y-1, Vol Y-2 Model II Dependent variable: target price Independent variable: current market price, growth rate of sensex, beta, PAT Y-1, Vol Y-1, HPR

Findings
Accuracy Metrics:

Accurate Accurate Accurate Accurate Accurate forecast with forecast with forecast with forecast with forecast with 5%* 10%* 15%* 25%* 35%* 4.55% 9.09% 13.64% 22.73% 40.91%

* Percentage deviation of target price from actual price

Findings
Magnitude of the forecasting error:
Positive error signals an excess of optimism in forecasting Negative error signals an excess of pessimism in forecasting Metric I Percentage of optimistic forecast Percentage of pessimistic forecast 50% Metric II 59.09091%

50%

40.90909%

Metric I: % deviation of target price form actual price wrt current price Metric II:% deviation of target price from the maximum or minimum price wrt current price

Findings
Model I:
Regression Statistics Multiple R 0.992122 R Square 0.984305 Adjusted R Square 0.975854 Standard Error 139.3594 Coefficients Standard Error t Stat P-value Intercept -209.452 104.7700834 -1.999158855 0.066941 CMP 1.086357 0.040665268 26.71462787 9.59E-13 Growth rate of sensex 150.8393 222.0398334 0.679334518 0.508841 Beta 253.1846 102.6761641 2.465855818 0.028355 PAT Year -1 0.225768 0.106050532 2.128873375 0.052958 PAT Year -2 -0.1176 0.102312574 -1.149409925 0.271095 V Year -1 -2.2E-06 1.65095E-06 -1.3525525 0.199257 V Year -2 1.92E-07 8.0143E-07 0.239038208 0.814803

Target Price = -209.452 + 1.086CMP + 150.83 G + 253.18 Beta + .2257 PAT Y-1 - .1176 PAT Y-2 2.2E-06 Vol Y-1 + 1.92E-07 Vol Y-2

Error percentage(actual - estimated) 5% 22.72727273 10% 45.45454545 15% 59.09091 20% 63.63636

Findings
Model II:
Regression Statistics Multiple R 0.992059 R Square 0.984181 Adjusted R Square 0.977854 Standard Error 143.4217 Intercept CMP Growth rate of sensex Beta PAT Year -1 V Year -1 HPR

Target Price = -168.326 + 1.084CMP + 243.13 G + 214.53 Beta + .0914 PAT Y-1 1.5E-06 Vol Y-1 + 5642.509 HPR
t Stat -1.34298 27.67803
1.280668 2.209764 2.138479 -2.37049 0.097608

Coefficients Standard Error -168.326 125.3382 1.084849 0.039195

243.1368 214.539 0.091421 -1.5E-06 5642.509 189.8515 97.08685 0.04275 6.42E-07 57807.99

P-value 0.199249 2.73E-14

0.219759 0.043085 0.04934 0.031593 0.923536

Error percentage(actual - estimated) 5% 22.72727 10% 31.81818 15% 54.54545 20% 63.63636

Practical application
An insight into the accuracy level of analyst report and make investors cautious of overdependence on the reports

. -

To determine the contributing factors towards accuracy of analyst report If those factors are very volatile then the accuracy of analyst report is under doubt
The models can be used to forecast future price/target price with 10% of significance level