The End of Accounting and the Path Forward for Investors and Managers

Chapter 2And You Thought Earnings Are the Bottom Line

In which we burst the myth that “earnings move markets” by showing that the time-honored ritual of financial analysts and investment managers of predicting companies’ earnings and basing investment decisions and recommendations—buy, sell securities—on these predictions, can be bested by simpler investment routines. Further, we show that the specter of companies missing the dreaded consensus earnings estimate has lost much of its relevance to investors. This is your first exposure to the fast-diminishing usefulness to investors of financial information—a major topic of this book.

The Lucrative Earnings Prediction

Forecasting corporate earnings (income) is a major endeavor of financial analysts, whether working for investment banks and independent outfits (sell-side analysts) or hedge funds and private equity firms (buy-side analysts). Financial (accounting) information is, of course, an important input into the earnings forecast models. Analysts use these forecasted earnings to form their stock recommendations to clients¹ and these forecasts also serve as the main benchmark—the consensus estimate—to evaluate corporate performance. Analysts' earnings forecasts (estimates), therefore, exert both direct and indirect effects on the equity investment decisions of most investors.

Many corporate managers play an active role in analysts' earnings forecasts by assisting (guiding) analysts in the prediction of sales and earnings. ...