“For a test case of Wall Street analysts’ perverse incentives, look no further than Apple Inc. After rising to giddy heights, the stock has been unable to catch a break lately,” Mark Hulbert writes for MarketWatch. “That is in no small part due to those incentives, which cause bad news to get incorporated into stock prices only gradually. One surprising consequence, according to researchers, is that unfavorable news tends to come in waves rather than being randomly interspersed with good news.”
“With Apple’s stock 36% lower today than its September high, some investors might argue that the current [lowered] consensus forecast is a case of closing the barn door after the horses have left,” Hulbert writes. “Unfortunately, the news is likely to get even worse, according to Michael Clement, an accounting professor at the University of Texas at Austin who has extensively studied analyst behavior. That is because a downward revision is more likely to be followed by yet another downward revision than by an upward one.”
Hulbert writes, “There are several sources of this tendency, he says. One is that analysts are slow to react to new information… But other reasons are more questionable. For example, according to Clement, analysts often are reluctant to offend a company’s management, which might retaliate by restricting their future access. Analysts also are reluctant to upset institutional clients who own big positions in a stock, and who therefore don’t want the analyst to be talking its price down. Because of these ‘powerful incentives to not get the bad news out,’ as Clement puts it, the market reacts far more quickly to unfavorable developments than do the analysts themselves. As a result, the typical analyst is more likely to follow the market than lead it.”
Read more in the full article here.