Exhibit 16.2 Share Prices and EPS for 15 Cyclical Companies

Exhibit 16.2 Share Prices and EPS for 15 Cyclical Companies

Are Earnings Forecasts the Culprit?

How can we reconcile theory and reality? We examined the earnings forecasts for cyclical companies to see if they provided any clues on the assumption that the market values of the companies would be linked to consensus earnings forecasts.

What we found was quite surprising. Consensus earnings forecasts for cyclical companies appeared to ignore cyclicality entirely. The forecasts invariably showed an upward sloping trend, regardless of whether the companies were at the peak or trough of the cycle. It appeared not that the DCF model was inconsistent with the facts but that the earnings and cash flow projections of the market (assuming the market followed the analysts' consensus) were to blame.

The conclusion was based on an analysis of 36 U.S. cyclical companies during the years 1985-1997. We divided them into groups with similar cycles (e.g., three, four, or five years from peak to trough), and calculated scaled average earnings and earnings forecasts. We then compared actual earnings with consensus earnings forecasts over the cycle.1

Exhibit 16.3 plots the actual earnings and consensus earnings forecast for the set of 15 companies with four-year cycles in primary metals and manufacturing transportation equipment. The consensus forecasts do not predict the earnings cycle at all. In fact, except for the ''next-year forecasts" in the years beginning from the trough, the earnings-per-share are forecasted to

1 Note that we have already adjusted downward the normal positive bias of analyst forecasts to focus just on the cyclicality issue. V.K. Chopra, "Why So Much Error in Analysts' Earnings Forecasts?" Financial Analysts Journal (November/December 1998), pp. 35-42.

Exhibit 16.3 Actual EPS and Consensus EPS Forecasts for Cyclical Companies

— Actual EPS -Forecasted EPS

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