Does their cultural background affect analyst forecasts?
I have written previously about new research that shows that analyst recommendations – contrary to wide held beliefs do add value in terms of outperformance vs. a buy and hold strategy. It seems that the United States is the outlier insofar that analyst recommendations there do not add value while in other countries, they do. But since most studies are done with US data, it became common knowledge that analyst recommendations aren’t creating outperformance. We might have to revise that view, but today, I want to focus on another dimension that was investigated in that research. That research also showed that analyst recommendations are more valuable in less developed countries and in less individualistic societies. The chart below is from that research paper and shows the outperformance of analyst recommendations relative to the countries’ individualism score for the developed countries only. Analysts in countries with lower individualism tend to make better recommendations.
Analyst recommendations and country individualism
Source: Hofstede, Azevedo and Muller (2020).
Interestingly, another study was published recently as a working paper that looked at analysts based in the United States, covering US stocks but coming from different national backgrounds. This study showed that even those analysts working in the United States differ in their recommendations and forecasts. Analysts with a background from a more individualistic culture like the United States, the UK, Australia, or Canada tended to make more and bolder forecasts. They want to differentiate themselves and stick out of the herd by making grandiose forecasts based on their private information.
Analysts from a cultural background that is more collectivistic in nature, on the other hand, tend to underweight their own insights and focus more on the prevailing consensus. These analysts tend to make more moderate forecasts. But as every seasoned investor knows, bold forecasts rarely come true. In fact, the more aggressive a forecast is, the more likely it is to fail. Good investors have learned to ignore the extreme bulls or bears in the market because they know they just add noise and no value.
However, if an analyst who isn’t normally given to bold forecasts suddenly starts to make one, one should pay attention. And that is what seems to happen with analysts from different cultural backgrounds as well. Analysts from individualistic cultures make bolder forecasts and do so more often, but over time, market reactions to these forecasts are diminished. Meanwhile, if an analyst from a less individualistic culture makes a bold forecast, the market reacts more, and investors pay more attention. And the empirical evidence indicates that they are right to do so. If an analyst who isn’t known for flashy and bold forecasts starts to make some, that tends to be a real signal that adds a lot of value to investors.