Analysts' earnings forecasts are not perfectly correlated with actual earnings. One statistical consequence is that the most optimistic and most pessimistic forecasts are usually too optimistic and too pessimistic. The forecasts’ accuracy can be improved by shrinking them toward the mean. Insufficient appreciation of this statistical principle may partly explain the success of contrarian investment strategies, in particular why stocks with the most optimistic earnings forecasts under perform those with the most pessimistic forecasts.
The research study can be found in Research Dialogue 64.
