Inconsistencies in equity analyst revisions may have rational explanations

LAWRENCE — Equity analysts produce outputs that include stock recommendations, earning estimates and 12-month target prices. But often, different outputs issued by the same analyst at the same time conflict with one another.

When investment banking deals are involved, analysts tend to appease the management by revising their recommendation or target price, while they try to be accurate for the EPS (earnings per share) forecast. So sometimes they go the other direction, and it can be seen as inconsistent.

“Everybody has pressures that would lead to inconsistencies. That’s well-known in the prior literature. I wouldn’t deny that happens,” said Min Park, assistant professor of business at the University of Kansas.

“But the bigger picture is that there is a rational reason behind these inconsistencies. Basically, there are accounting or economic factors why analysts revise their outputs in what looks to be an inconsistent manner.”

His article “Seemingly Inconsistent Analyst Revisions” appears in the Journal of Accounting and Economics.

In research co-written with Michael Iselin and Andrew Van Buskirk, Park found that in 20-30% of cases where an analyst revises two outputs simultaneously, these estimates get revised in opposite directions. Their study began by documenting the prevalence of discrepancies within these pairs.

Park said, “Prior literature associates analyst inconsistency mostly with conflicts of interest related to investment banking activities. Essentially, they are considered ‘bad analysts.’ It’s assumed because of conflicts of interest, they are behaving strategically.”

These contradictory outputs are viewed as less valid by investors. However, Park wrote they “are neither less accurate than consistent outputs, nor do they resolve less investor uncertainty upon their release.” His results suggest researchers should remain cautious in interpreting such analyst outputs as a measure of bias or quality.

For example, if an analyst is revising earnings estimates and a target price on the same day for, say, Tesla, they may revise them in different directions, thus implying inconsistency in their work.

“But we are saying that’s not always true. They’re incorporating accounting and other economic factors into their valuation model. They’re totally rational in doing that, and just because they revised one output down and the other up, it doesn’t mean they’re foolish. We should not see that as less credible. They’re doing the right thing,” he said.

Prior to his academic career, Park was a sell-side equity research analyst covering South Korean stocks. Did that help with researching and writing this article?

“I’m not saying I know everything about the full picture, but as a former practitioner, I at least have some intuition about what’s going on behind these seemingly inconsistent revisions — because I was the one who actually did these things,” he said.

Now completing his first year at KU, Park’s expertise focuses on capital markets and information intermediaries such as analysts and institutional investors.

He’s optimistic “Seemingly Inconsistent Analyst Revisions” may help those in his industry rethink how they view irregularities.

“Hopefully, academic researchers appreciate there are other rational factors behind these analyst revisions,” he said. “And also for practitioners and investors, they will consider those rational factors when they’re interpreting analyst outputs which are seemingly inconsistent.”

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