Benefits and traps in using consensus forecasts
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Christine St Anne is Morningstar's online editor.
Each reporting season, the financial press is packed with news about whether or not company earnings have met analysts' consensus forecasts.
This article takes a closer look at what constitutes consensus data and how analysts use this data in assessing the value of a company.
What are consensus analyst forecasts?
Analysts use models and fundamental analysis to come up with an estimate of how an Australian Securities Exchange-listed company will perform in the future.
A figure based on the combined estimates of analysts covering an ASX-listed company is called a consensus estimate.
Generally, three-year estimates are made on the following company data: 1. consensus recommendation; 2. sales; 3. net profit after tax; 4. earnings per share (EPS); and 5. dividends per share.
The size of the company and the number of analysts covering it will dictate the size of the pool from which the estimate is derived.
A consensus forecast figure is normally an average or median of all the estimates from individual analysts tracking a particular share.
For example, an earnings estimate for XYZ Limited of 50 cents for 2014 means XYZ is expected to earn 50 cents a share next year.
The equities research team at Morningstar look at consensus data but do not use it within their research processes.
"The whole basis of our fair value (on a company) is based on our own estimates of company earnings and cash flow," Morningstar head of equities Andrew Doherty says.
"Our job is to form our own view about the company's prospects. We do our own work to understand the company's outlook in terms of their earnings and market positioning. This feeds into our own model," Doherty says.
"Consensus data can help. We can do without consensus estimates but analysts need to compare their analysis just to get an understanding of where they sit and how they compare in the market," he says.