Bottom-up analysts ignore the big picture

INVESTORS nervously considering the forces acting on their share portfolios are caught between two opposing camps.

On one side, the company-focused analysts are still basking in 15 years of economic sunshine, confidently forecasting profit growth in industrial companies this financial year of a rosy 9 per cent.

On the other, the macro-economic analysts - known as equity strategists - are predicting a fall in profit growth in the same companies by up to 10 per cent.

They can't both be right.

It makes a weird time in the sharemarket even weirder when the macro analysts in one stockbroking firm find themselves in violent disagreement with the company-based analysts in the same firm.

In a report this week, a Goldman Sachs JBWere equity strategist, Chris Pidcock, said: "We continue to believe that the EPS [earnings per share] growth forecasts … remain too optimistic (in particular fiscal year 2009), with sales growth and margins still at unrealistic levels given the macro and domestic outlook."

And this was after the company-based analysts there downgraded their 2009 profit growth expectations for industrial companies from 12.1 per cent to 8.4 per cent.

Last month, Macquarie Group's equity strategists predicted a fall in profit among industrial companies of up to 10 per cent in 2009, against a company-based analyst consensus of more than 10 per cent growth.

"You have got a set of numbers that assumes some sort of recovery," Macquarie's equity strategist, Tanya Branwhite, said when releasing the report. "Unfortunately, that's premised on the cycle we have seen in the last five to 10 years. What is facing the economy at the moment is nothing like we have seen in the last five to 10 years."

Brian Han, an analyst for the fund manager Constellation Capital, also believes company-based analysts may find it hard to give up extrapolating from the bull market conditions experienced in the past five years.

"When you are a bottom-up analyst [after] such a period of conditions, bull market conditions, the easiest practice is to say it will recover in 12 to 18 months," he says.

Part of the problem is the information analysts receive from the companies.

Don Williams, the chief investment officer of Platypus Asset Management, says of company guidance: "At the moment most of them will tell you it's tough, but we expected it to be tough. There hasn't been a lot of changes to guidance outside of retail and other specific companies. That's probably the reason a lot of the bottom-up guys are hanging on to their numbers."

But Mr Williams is expecting any company guidance on future profits in the forthcoming reporting season to be severely constrained. "Not many corporates come out and say, 'Our outlook for the next two years is completely stuffed'," he says.

Mr Han agrees there will be a lack of guidance. "If I were a chief executive I wouldn't be brave enough to predict 12 months out."

But, funnily enough, Mr Han expects this lack of guidance will eventually push the two divergent forecasts closer together, because company-based analysts will be forced to read the economic signals to divine a company's fortunes. "What they earn is a function of where the economy goes," he says.

Roger Montgomery, the managing director of the fund manager Clime Asset Management, says company-based analysts look at the wrong things and in too short a time frame.

"Analysts live in a world that the rest of Australia doesn't inhabit. They live in that very narrow real estate band from the beach to the Harbour Bridge," he says.

"They don't travel west beyond that and as a result they are not attuned to what, in this case, the economists can see."

But Mr Montgomery, who espouses long-term value investing, argues they are too short-term in their views - generally focused on next year - rather than a company's growth over a five- to 10-year period.

As for the "value" that is being found in the sharemarket after it fell through 5000 points, there is probably one simple question to be asked of company-based analysts.

If even their own colleagues do not believe their profit forecasts, why would you believe their predictions of value?