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Research notes: comparison of top-down and bottom-up earnings forecasts.

IN AN EARLIER PAPER, "Business Economists, Forecasting, and Markets," I presented an analysis of business economists' forecasts of GNP, inflation, interest rates, and profits. The purpose of the analysis was to provide some perspective on the role our profession can and should play in contributing to effective business decisions; some suggestions for improving our performance and communications were also included.

The editor was more than generous in his allocation of space to the paper, but even so many of the exhibits could not be included. One specific set of charts related to earnings forecasts were thought to be of interest, and an updated version (including 1991) is presented below.

The forecasts are made for the index of earnings per share that is constructed for the companies included in the Standard and Poor's 500 Index of stock prices. These are the book (or shareholder) earnings reported by individual companies and then aggregated to the total by Standard and Poors. Two types of estimates have been used in the investment community -- "top-down" forecasts made by portfolio strategists and economists and "bottom-up" estimates made by securities analysts for the individual companies included in the index. IBES has collected these estimates for about ten years. The top-down figure is an average of those made at brokerage firms. The bottom-up numbers are collected from security analysts at the same firms; the average for each company is then calculated, and they are aggregated together to produce an estimate of earnings for the total S&P 500 index.

Charts 1-9 show the forecasts and the actual results for each year 1983-91. The actual earnings are plotted at the end of the year in question; in fact, of course, the result for any year does not become known even on a preliminary basis until March or April of the next year when company reports are finally published. The forecasts are shown as they are collected each month, beginning about two years before the end of the target year.

Several tendencies are quite apparent from the charts:

1. The forecasts have generally started much higher than the actual outcomes and have gradually come down. Two exceptions to this rule are 1988 and 1989.

2. Generally, the top-down estimates have been closer to the mark than the bottom-up predictions. The error statistics presented in the earlier report provide a quantitative verification of this point, although neither type of forecast has been very accurate.

One of the reasons for the difference -- and indeed for the errors -- is unanticipated developments or nonrecurring charges that companies take when they restructure their activities, discontinue an operation, or sell a unit. Analysts are usually working on the presumption there will be no unusual company developments or special charges in the current period. Top down forecasters, however, may be willing to assume some average amount of write-offs without attributing them to any specific companies.


I/B/E/S (Institutional Brokers Estimate System), Lynch, Jones and Ryan, Monthly Comments, various dates.

Rippe, Richard D., "Business Economists, Forecasting, and Markets," Business Economics, XXVII, No. 1, January 1992, pp. 13-20.

Standard and Poor's, The Analysts Handbook, Monthly Supplement, April 1992.
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Author:Rippe, Richard D.
Publication:Business Economics
Date:Jul 1, 1992
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