An International Comparison

of Analysts' Earnings Forecast Accuracy

MICHAEL FIRTH AND MICHAEL GIFT*

A major task of financial analysts working for stockbrokers and investment finns is to
forecast future earnings of listed companies. The usefulness of their work crucially depends on
the accuracy of the forecasts. A great many studies have examined the accuracy, bias, and
other characteristics of profit forecasts made in the U.S. In contrast, however, there is vet),
little research on forecasting accuracy in other countries despite the increasingly global nature
of investing. This paper examines the accuracy of corporate earnings forecasts in 34 different
countries. In addition, a model is developed that seeks to explain differences across companies
and countries. The findings show that eight countries have better forecast accuracy than the
U.S. This cross-sectional model shows that with the inherent difficulty in forecasting for a
specific company (proxied by the change in its earnings), risk and the number of analysts
following the stock are the major factors in explaining earnings forecast accuracy. (JEL G24,
m41)

Introduction

There is a substantial body of research that has examined the accuracy of financial
analysts' earnings forecasts. To date, however, most of the empirical studies relate to
analysts' forecasts in the U.S. 1 Recently, a few studies have emerged from Britain (for
example, Bhaskar and Morris [1984], Capstaff et al. [1995], Cho [1994], Forbes and
Skerratt [ 1992], and O'Hanlon and Whiddett [ 1991 ] ), Canada [Hennessey, 1994], France
[Jacquillat and Grandin, 1994], Hong Kong [Lui, 1993; 1995], Japan [Conroy and
Harris, 1995; Mande and Kwak, 1996], and Malaysia [Paudyal et al., 1996]. In contrast,
there are very few studies that compare and contrast financial analyst forecasting across
nations. The purpose of this paper is to provide some basic analyses on earnings forecast
accuracy in 34 countries and to develop a simple model to explain differences among
nations.
Research into the accuracy of financial analysts' earnings forecasts is valuable for a
number of reasons. First, earnings forecasts and revisions in forecasts are major
determinants of stock prices and stock price changes. Assessing the accuracy of forecasts

*HongKongPolytechnicUniversityand LingnanCollege--Hong Kong. The authorsgratefullyacknowledge

the insightfulcommentsmadeby the participantsat the Forty-FifthInternationalAtlanticEconomicConference
in Rome, Italy, March 14-21, 1998. Their helpful suggestions have been incorporated into this paper. The
authors also acknowledgethe contribution of the Institutional Brokers Estimate System, Inc. tbr providing
earnings per share forecastdata and is availablethrough them. This data has been provided as part of a broad-
based academicprogram to encourageearnings expectationsresearch.

56
 FIRTH AND GIFT: FORECAST ACCURACY 57

can be used to help improve future forecasting and help investors make choices between
analysts. Second, earnings forecasts may be used as inputs into the deliberations of
regulators and policymakers. Third, profit forecasts are often used by researchers as a
benchmark in studies on financial markets and accounting issues. Cross-national
comparisons of earnings forecast accuracy are important because, as investors increase
their exposure to foreign stocks, they need to learn more about global markets. The rapid
internationalization of individual stock markets, where foreign firms list on domestic
exchanges, also leads to a demand for more cross-border studies.

Research Design
Sample
This sample data come from both the domestic (U.S.) and the international Institutional
Brokers Estimate System (IBES) databases. Currently, the international database covers
48 countries 2 and incorporates data from as early as 1987. As of 1997, approximately
15,000 non-U~S, companies are represented in IBES. Because the sample sizes were
somewhat small in the late 1980s and early 1990s, earnings forecasts were examined from
1994 through 1997. For the purpose of this research, only the forecasts recorded one
month prior to the earnings announcement date were examined. These forecasts will be
more accurate than those observed at earlier dates as virtually all studies find that forecast
errors decrease as the forecast horizon shortens.
IBES records the forecasts made by individual analysts (often ten or more individual
forecasts) and updates the records each month. The dates on which individuals make their
earnings estimates, within each month, are reported. Consensus forecasts and dispersion
of forecasts are also calculated each month. The latest forecast made in each month was
chosen for this study. Prior research has shown that the latest forecast in a given month
is the most accurate. Presumably, the latest forecast can impound knowledge of all
previously made forecasts and can incorporate all publicly available information up to the
date of the forecast.
In common with other studies in this area, this paper uses screening devices to detect
and adjust for outliers. Forecast errors greater than 1.50 and less than -1.50 are recorded
as 1.50 and -1.50, respectively. A similar rule is used for actual changes in profits.
Thresholds of 1.00 or 1.50 are the most common in this type of research. Companies
with negative earnings are omitted as it is difficult to interpret the results of calculations
involving negative denominators.
The screening devices employed and the need for countries to have been in the
database from 1994 onward results in a total of 34 nations being represented in the final
sample. The overall sample size and the sample size for each country are presented in
Table 1.
Accuracy Measures
Two measures of forecast errors are computed for each firm and for each time period.
They are the forecast error and the absolute forecast error. The forecast error (FE) is
defined as:
58 IAER: FEBRUARY 1999, VOL. 5, NO. 1

FElt m = (Ait- Fitm) IA. , (1)

where FE is the forecast error, All is the actual earnings of firm i in year t, and Fit,,' is
the latest forecast in month m of the earnings for firm i in year t. The mean of the FEs
for a given month m measures whether there is any systematic bias in earnings forecasts
(that is, forecasts exceeding actual or vice versa). If there is no bias, then FE should equal
zero.
The absolute forecast error (AFE) is:

AFE.m = I(A.- Fit m) IA. I , (2)

where AFE is a measure of the accuracy of the forecasts.

In order to help assess the absolute forecast errors, compare the AFEs with the
predictive accuracy of a simple time series extrapolation based on the random walk
model. The random walk model forecasts this year's profit (RWF) as being the same as
the immediately preceding year' s profit. The absolute forecast error based on the random
walk model is denoted AFE(RW) and is thus constructed:

AFE(RW). = ](Ait - RWF.)/A. t , (3)

where AFE(RW) is the absolute actual change in profit (as Ait_l = RWFit ) as well as
being the absolute error from the random walk prediction model. A high value for
AFE(RW), can be interpreted as a signal that corporate earnings for that company are
more difficult to forecast. If the actual change in earnings is large, then analysts' forecasts
will tend to be less accurate. It is hypothesized that financial analysts should be able to
make far better forecasts than those from simple statistical extrapolations. Analysts use
the simple no-change model as one input into their forecasts. In fact, the random walk
prediction is probably the starting point in many analysts' forecasting processes. Financial
analysts have advantages over time series models in terms of information used,
knowledge of forecasts made by other analysts, and timing.
In this paper, a simple comparison is made between the mean AFEs and AFE(RW)s
across countries. In addition, AFE(RW) is used as an explanatory variable in these cross-
sectional models. Comparing analysts' forecasts to those from a random walk model has
been used in other accuracy metrics such as the analyst superiority measure of Brown et
al. [1987] and the bias and rationality tests of Capstaff et al. [1995] and De Bondt and
Thaler [ 1990].
There is a lot of variability in AFEs across companies, so a number of simple models
are developed in an attempt to help explain the differences. AFEs are modeled as a
function of size, the number of analysts actively following the company, the risk of a
country, and the errors from a random walk prediction. Company size, measured by
market capitalization at the date of the forecast, is hypothesized to have a negative
relationship with AFE. Larger companies' profits may be easier to estimate as they have
 FIRTH AND GIFT: FORECAST ACCURACY 59

more control of their market settings and, therefore, have greater influence over the level
of their profits. There tends to be more information on large companies, including greater
direct disclosures from the firm itself. This leads to:
H1: There is a negative relationship between size (SIZE) and AFE.
Forecasting accuracy is expected to be a function of the number of financial analysts
who actively follow a specific company. The forecasts of individual analysts become
known to other analysts along with the reasons for those forecasts. This process leads to
greater information sets being available, and it allows analysts to review and revise their
own forecasts in light of the estimates made by others. As this paper uses the latest
forecast in a month, this has the benefit of incorporating information from all previous
estimates. IBES reports the number of analysts who revise their forecasts for a specific
company within a particular month. The number of revisions proxies the number of
analysts who actively follow the company. The hypothesis is:
H2: There is a negative relationship between the number of analysts who revise forecasts
during a month (NOAN) and AFE.
Forecasting accuracy is likely to be a function of the risk class in which a company
operates. There are many measures of risk but they are often difficult to operationalize
in an international comparison setting. Company risk is partly dependent on the country
where the company is located, and preliminary analyses indicated that forecasting
accuracy varies across nations. Instead of using dummy variables for countries, country
risk metrics are chosen here. The PRS Consultancy Group provides a comprehensive
coverage of risk measures by country. In particular, they provide measures of political
risk, economic risk, financial risk, and composite (political, economic, and financial)
risk. The risk measures are on a scale of 0 to 100 with 100 being very low or no risk, and
0 is extremely risky. The financial risk score and the composite score is used here. It is
hypothesized that high-risk countries will be associated with low forecast accuracy. Given
the nature of the PRS ratings (high score equals low risk), the following hypothesis is
derived:
H3 : There is a negative relationship between composite risk (or financiat risk) and AFE.
It is more difficult to forecast the earnings of some companies than for others.
Differences in product markets, technologies, exposures to interest rate and exchange rate
changes, national economic policies and conditions, and other factors lead to differences
in accuracies across companies and countries. It is difficult, however, to construct models
to account for all of these factors. It is argued here that the accuracy of a no-change
earnings forecasting model is an overall indicator of the forecasting difficulties faced by
financial analysts. This leads to the following hypothesis:
H4: There is a positive relationship between change in actual profits (AFE(RW)) and
AFE.
The hypotheses are tested via the following regression model:
60 IAER: FEBRUARY 1999, VOL. 5, NO. 1

AFE = ~o + [31SIZE+ ~2NOAN + ~ 3 C R I S K + •4AFE(RW) , (4)

where: AFE = absolute forecast error; SIZE = market capitalization measured in U.S.
dollars at the date of the forecast; NOAN = number of analysts who revise their forecasts
in the month prior to the earnings announcement; CRISK = composite risk measure for
the country in which the company is domiciled (the composite risk is obtained from PRS);
and AFE(RW) = absolute forecasting error from a random walk model. It is the same as
the absolute change in profits from year t - 1 to year t.
An alternative measure of risk, financial risk (FRISK), is also used in the regression.
Thus, FRISK = financial risk measure for the country in which the company is domiciled
(the financial risk is obtained from PRS).

Results
Bias and Accuracy
Table 1 presents the basic results on bias and accuracy. The mean bias (derived from
(1)), mean absolute forecast errors (from (2)), and the absolute forecast errors from the
random walk model (see (3)) are shown. The means are computed for the overall sample
by individual country, continent, and whether IBES classifies a country as a mature
market or an emerging market.
The overall bias is 0.27 percent which is not statistically different from zero
(t = 0.987). Although financial analysts make errors in their forecasts, there is no
systematic over- or under-forecasting evident in the data here. The mean absolute forecast
error for the whole sample is 11.51 percent. This error (11.51 percent) compares with
the mean absolute forecast error from a no-change model of 40.41 percent. As expected,
the analysts do a much better job of forecasting than does the random walk model.
The biases (FEs) range from 0.01 percent in Japan to 15.03 percent in Indonesia.
Fourteen of 34 countries have negative bias where the actual earnings are less than the
forecast earnings. The mean AFEs range from 1.74 percent in Austria to 33.45 percent
in Brazil. In all countries, the mean AFEs are less than the mean AFE(RW)s, therefore
showing analyst superiority over simple time series models. Accuracy is particularly poor
for South and Central American countries, and all four constituent countries (Argentina,
Brazil, Chile, and Mexico) have high AFEs. South American companies also have the
greatest positive bias metric. Scandinavia (Denmark, Finland, Norway, and Sweden) also
has a high AFE, and the negative bias statistic shows that financial analysts' forecasts are
too high. IBES categorizes some countries as emerging markets and others as mature
markets. Although some of the selections may be debatable (for example, Hong Kong,
Korea, and Singapore are treated as emerging markets), the bias and accuracy of
emerging markets and mature markets are calculated. The emerging markets have lower
accuracies than the mature markets, although the difference is not large.
 TABLE 1
Earnings Forecast Bias and Accuracy by Country

Mechanical Mechanical
Bias Accuracy Accuracy Sample Country Bias Accuracy Accuracy Sample
Country (MFE) (MAFE) (MAFE(RW)) Size and Continent (MFE) (MAFE) (MAFE(RW)) Size

All Countries 0.0027 0.1151 0.4041 9,515 Netherlands 0.0226 0.0808 0.2981 176
Argentina 0.0062 0.2210 0.5211 49 New Zealand 0.0098 0.1111 0.2709 88
Australia -0.0065 0.0657 0.2775 290 Norway -0.0406 0.2129 0.4650 69
Austria 0.0039 0.0174 0.4765 63 Pakistan 0.0090 0.2130 0.5083 19
Brazil 0.0635 0.3345 0.6901 118 Philippines -0.0235 0.1118 0.2716 85
Chile 0.1397 0.2291 0.3947 66 Singapore 0.0163 0.0754 0.2616 167 ¢3
China 0.0684 0.1509 0.5043 53 South Africa 0.0238 0.0717 0.3337 122
°°
Denmark -0.0146 0.1292 0.3865 101 Sri Lanka 0.0154 0.0648 0.4192 33
Finland -0.0647 0.2475 0.6147 68 Sweden -0.0275 0.1553 0.4668 133
France 0.0602 0.1590 0.3962 332 Switzerland -0.0511 0.1413 0.4374 138
Germany -0.0004 0.1364 0.3923 232 Taiwan 0.0317 0.1638 0.4297 144 ;>
Greece -0.0119 0.0961 0.4061 160 Thailand 0.0060 0.1135 0.4159 198
Hong Kong 0.0441 0.1156 0.2756 229 Turkey 0.0199 0.0799 0.5678 175
¢3
India 0.0732 0.1479 0.3651 130 UnitedKingdom -0.0212 0.1000 0.2654 747
Indonesia 0.1503 0.2004 0.4248 109 UnitedStates -0.0089 0.0927 0.3581 2,964
;>
Ireland -0.0175 0.0840 0.3134 38 Asia 0.0132 0.1222 0.4649 3,276 ¢3
,<
Israel 0.0038 0.1203 0.1298 3 Australasia -0.0027 0.0763 0.2759 378
Japan 0.0001 0.1194 0.5577 1,896 Europe 0.0010 0.1099 0.3590 2,061
Malaysia -0.0131 0.1060 0.2511 243 Scandinavia -0.0332 0.1758 0.4717 371
Mexico -0.0373 0.3052 0.7021 77 South America 0.0551 0.2869 0.6035 410

Mature Markets -0.0053 0.1080 0.4054 7,335 Emerging Markets 0.0299 0.1390 0.3998 2,180

Notes: M in MFE, MAFE, and MAFE(RW)denotes the mean across all observations in a country or category.
62 IAER: FEBRUARY 1999, VOL. 5, NO. 1

The accuracy of earnings forecasts of U.S. companies may be used as a benchmark

against which to compare other countries. Disclosure requirements and practices,
economic stability, experience, and the intensity of financial analysis, may suggest that
forecasting accuracy should be highest in the U.S. The data here, however, show that
approximately one quarter of the countries examined in this study have smaller AFEs than
the U.S. Cho [1994] and Conroy and Harris [1995] have previously concluded that
forecasting accuracy may be better in the U.K. and Japan vis-gt-vis the U.S. The study
here finds very little difference, however, between the forecasting accuracies of the U.K.
and U.S. and Japan and the U.S.
Cross-Sectional Explanatory Model
The results from the regression equation are shown in Table 2. Two proxies are used
for risk. They are composite risk (CRISK) and financial risk (FRISK). These two
variables are highly correlated, so they are included one at a time in the regressions. The R 2 s
of 10.40 percent and 10.42 percent compare well with other cross-sectional models
reported in the literature on analysts' forecasting accuracy.

TABLE 2
Cross-Sectional Regression Models of Absolute Forecast Errors (AFEs)

Variables Coefficients t- Statistics Coefficients t-Statistics

Intercept 0.1304 (4.18)* 0.0878 (4.41)*

SIZE -0.0000 (-1.26) -0.0000 (-1.36)***
NOAN -0.0015 (-1.49)*** -0.0016 (-1.57)***
CRISK -0.0010 (-2.71)*
FRISK -0.0011 (-2.11)**
AFE(RW) 0.1813 (32.53)* O. 1825 (32.59)*
R2 0.1042 O. 1040

Notes: * denotes significanceat the 0.01 level, ** denotes significance at the 0.05 level, and ***denotes
significanceat the 0.10 level.

SIZE has the expected negative sign, but statistical significance is weak. NOAN has
negative coefficients as expected, although they are only significant at the 0.10 level. The
evidence suggests that greater financial analyst scrutiny of a company leads to more
accurate earnings forecasts. Therefore, Hypothesis 2 receives moderate support from the
data here. Risk in the forms of CRISK and FRISK is significant at the 0.01 and 0.05
levels, respectively, and the negative directional signs are consistent with expectations.
 FIRTH AND GIFT: FORECAST ACCURACY 63

The evidence supports Hypothesis 3. The more risky a country is, the worse the earnings
forecast accuracy is for companies in that country.
The change in the absolute profits variable, AFE(RW), is highly significant in
explaining the absolute forecast errors. The positive sign indicates that large changes in
profits from year t - 1 to year t make earnings forecasts by financial analysts less
accurate. The results from Table 2 strongly support Hypothesis 4. Further analyses
suggest that AFE(RW) is the most important of the independent variables in improving
the explanatory power of the model. The coefficient on AFE(RW) is less than 1 which
is consistent with analysts' forecasts being more accurate than the forecast given by the
random walk model.
Country Analysis
These analyses demonstrate significant differences in forecasting accuracies across
nations, and there are a multitude of potential reasons for this. In this study, one potential
dimension is investigated, financial risk and composite risk. Other reasons for differences
between countries include disclosure regulations, accounting rules, tax regimes, corporate
governance structures, and national economic policies and conditions. Future research
will be directed toward investigating these factors.

Conclusions

This research is a preliminary investigation of differences in financial analyst

forecasting accuracies across companies and countries. The results indicate substantial
inter-country variability in measures of forecasting bias and accuracy. South and Central
America have the poorest accuracy, followed by the Scandinavian nations. Although the
U.S. is usually argued to have the greatest amount of disclosure and the largest degree
of investment analysis activity, the bias and accuracy measures are only average among
the developed or mature nations. Cross-sectional regression results showed that the proxy
for the inherent difficulty of forecasting, namely the absolute change in profits, is by far
the most important variable in explaining forecast accuracy. Company risk is
hypothesized to be another important determinant of accuracy, but it is difficult to
operationalize a measure which is valid across countries. Because the national
environment in which a company operates is likely to be a factor in a company's risk and
because national risk ratings are available, a firm's risk by its country's risk is proxied
here. The two measures of country risk, composite risk, and financial risk, are
statistically significant and have the expected directional signs. Two other explanatory
variables, size and number of analysts who actively research a company, have the
hypothesized negative signs, although the statistical significances are weak to moderate.
The models in this paper explain about 10 percent of the variability in forecast
accuracy, so there is considerable scope to investigate other factors that may influence or
affect earnings estimation errors. These factors will include environmental and
institutional features of the nation in which a company is domiciled. Further research on
this topic will add to the growing literature on the globalization, internationalization, and
cross-cultural differences of financial markets.
64 IAER: FEBRUARY 1999, VOL. 5, NO. 1

Footnotes

1. For review of this literature, see Brown [1993], Brown et al. [1985], and Givoly and
Lakonishok [1984].
2. Some of these countries have recently been added to the database so there is little or no data
available as yet.

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