Sorry, Wall Street Analysts, but You're Just Not Very Good at Your Job

By Sean Williams Markets Fool.com

As of Feb. 17, 2017, according to FactSet Research (NYSE: FDS), 82% of the companies in the S&P 500 (SNPINDEX: ^GSPC) had reported their fourth-quarter or fiscal Q4 earnings results. By the reaction of the S&P 500 since earnings reports began rolling out in mid-January, the assumption is that corporate profits must've been far better than anticipated.

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Are stocks grossly overvalued?

The data from FactSet in Q4 2016 might suggest otherwise. In total, just 66% of the already reported S&P 500 companies have topped Wall Street's EPS projection, and a meager 53% have surpassed the Street's sales estimate. Over the past year, 71% of companies have historically topped EPS estimates, so to have only 66% beat the Street's estimates is subpar. It's also 1% below the five-year average of 67%. In terms of revenue, the 53% "beat" is right on par with the five-year average and 1% higher than the one-year average.

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In addition, FactSet data shows that the forward P/E on the S&P 500 of 17.6 marks the highest level since Jun. 23, 2004. That figure places the S&P 500's forward P/E (as of Feb. 17) ahead of the five-year (15.2), 10-year (14.4), and 20-year (17.2) averages.

By all accounts, the data would suggest that stocks are becoming grossly overvalued and that investors might be wise to take their cash and head to the sidelines.

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But what if there were a considerably simpler answer?

Stocks aren't the issue -- our faith in Wall Street is

What if Wall Street analysts just aren't as exceptional as we've been led to believe they are when it comes to estimating how much S&P 500 companies will generate in revenue and profit?

Think about this for a moment. Over the past five years, just 53% of S&P 500 companies have surpassed Wall Street's quarterly sales estimates. That's basically no better than a coin flip. Yet the S&P 500 has shrugged off these "misses" as a whole and moved higher by roughly 65% on a trailing five-year basis.

Image source: Getty Images.

Why? Because S&P 500 companies have continued to grow. During Q4 2016, according to FactSet, the blended revenue growth rate was 5%, marking the second consecutive quarter of positive sales growth. With the exception of the telecom sector, all 10 other sectors have reported sales expansion in Q4. In other words, investors are anointing stocks with a higher valuation because there is actual sales growth, and they're shrugging off what seems likely an exceptionally high percentage of companies that have "missed the mark" in Wall Street's eyes.

By a similar token, about two-thirds of S&P 500 companies are regularly trouncing what seem to be conservative estimates from Wall Street on quarterly profits. This would suggest that the current forward P/E of 17.6, the aforementioned highest forward P/E we've seen in almost 13 years, will probably head lower if history serves true and corporate profits top expectations -- as they seem to do every quarter.

Stocks aren't overvalued. We've just lost sight of what's really important: actual company growth.

More reasons to be wary of Wall Street

But there's more to it than just Wall Street estimates that are way off kilter quite a bit of the time.

For starters, Wall Street analysts have no accountability to individual investors. If they rate a stock a "buy" and slap a profit estimate on a company, and that company goes on to completely miss that estimate and nosedives 10%, 20%, 50%, or more, the only ones likely to suffer are the individual investors who placed their faith in Wall Street. If an analyst is wrong, he or she may eat a bit of crow, but the institution itself that made the call isn't accountable to the individual investor one iota.

Image source: Getty Images.

Second, a lot of Wall Street's estimates and ratings tend to be reactive rather than proactive in nature. If an S&P 500 company misses Wall Street's guidance, which on a revenue basis happens essentially every other report, the covering analyst or firm simply reacts to the new data and adjusts the forecast. Wall Street analysts are often so focused on the short term that they may miss the far more important key long-term trends that generate real value.

Wall Street analysts are also bound by their firms' opinions. In other words, if a firm rates a stock as a "buy," then no other analyst in that firm can publicly offer a dissenting opinion. That doesn't exactly help the individual investor understand both sides of the story (i.e., the risks involved with a company), nor is it a particularly smart move to ignore potential risks.

Long story short: Wall Street has no vested interest in your investments, so why should you place your faith in their analysis? Use this data as a reason to dig deeper than Wall Street's surface-scratching headline figures and uncover the real growth drivers of the companies you own and follow. If you do, you'll probably be a far, far better investor over the long run than someone who places a portfolio in the hands of Wall Street's ratings and estimates.

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Sean Williams has no position in any stocks mentioned. The Motley Fool owns shares of and recommends FactSet Research Systems. The Motley Fool has a disclosure policy.