It's a scary time for the stock market right now. By all accounts, things seem to be getting better with the U.S. economy. Unemployment is finally starting to tick downward, and while the economy isn't growing at anything close to the pace that emerging nations like China have enjoyed, the U.S. seems to be on track not only to avoid a double-dip recession but also to see accelerating growth in the year ahead.
Still, there's plenty out there to fear. Europe's problems look like they'll be with us for a long time, and the potential fallout in the U.S. from the damage that European economies have already seen is hard to gauge. What's clear, though, is that the analysts who study individual companies are scared -- and they're marking down 2012 earnings estimates on a boatload of popular stocks.
Today, I want to look at the stocks from the Dow Jones Industrials (INDEX: ^DJI ) that analysts are most afraid of right now. I'm going to reveal the five Dow stocks that have seen the biggest reduction in analysts' earnings estimates over the past three months. But first, let's go over the history of how well analysts do at predicting stock moves.
Do the pros really know?
The problem with relying on Wall Street analysts to make investing decisions is that they're notoriously wrong. A few years ago, Penn State academics J. Randall Woolridge and Patrick Cusatis did a study of analysts' earnings estimates published over a 20-year period. The results were simple: Wall Street analysts are way too optimistic about stocks.
In particular, looking at earnings growth, analysts tended to guess high by 4 percentage points even when going only a single year into the future. Extend that period to five years, and the miss was even bigger -- almost 6 percentage points.
Put another way, what Woolridge and Cusatis found was that actual growth tended to come in a whopping 40% below what analysts had projected.
Why look, then?
So if analysts are so inaccurate, what's the point in looking to them? The answer is simple: Even if you don't care about analysts' numbers, the rest of the investing world does -- and their opinions have a direct impact on how your stocks perform. If analysts are downgrading their estimates on a stock, then you can expect trouble ahead -- and unless the company is able to surprise on the upside, you'll often see your stock suffer in the interim.
So with that in mind, here are the five Dow stocks for which analysts have ratcheted down their earnings estimates the most over the past three months.
Current EPS Estimate for 2012
Estimate 90 Days Ago
|Alcoa (NYSE: AA )
|Bank of America (NYSE: BAC )
|Hewlett-Packard (NYSE: HPQ )
|United Technologies (NYSE: UTX )
Source: S&P Capital IQ. As of Jan. 5.
In past weeks, we've already talked quite a bit about several of these stocks. On the financial side, a recent Bloomberg survey found that analysts expect profits for the nation's largest banks, which include both JPMorgan Chase and B of A, to jump 57% in 2012. Having been dreadfully wrong in 2011, it's likely that those analysts are simply backing off from already lofty numbers.
With Alcoa, concerns about a global downtown have toned down any analyst optimism about the stock. However, with positive news out of China and the U.S. on the manufacturing front, it'll be interesting to see whether analysts reverse this trend and start pushing their estimates on Alcoa back up. And as for HP, all bets are off in my view until new CEO Meg Whitman proves herself as a leader who can break the cycle of revolving-door governance at the company.
The most interesting play on this list in my opinion is United Technologies. The shares have bounced around over the past year, as optimism about the company's contribution to Boeing's 787 Dreamliner gave way to fears of government spending cuts and the bad news that Boeing had cut United Tech out of its 737 "MAX" design, choosing General Electric to make its engines instead. Yet as a cyclical stock, United Tech is in the best position to profit if a true turnaround has already taken root.
A grain of salt
Before you give up on all of these stocks, remember: Analysts are often wrong. If you can find the rare areas where they're being too pessimistic, you have a real opportunity to pick up shares on the cheap.
If you think United Technologies and the defense sector have more promise than analysts think, you'll want to read the Fool's latest special report on the sector. In the free report, we reveal two small-cap stocks that are too small to fail. Join the thousands who've already read about it: Grab your free copy today before it's gone.