Why the Crystal Ball Is Clouded

Why the Crystal Ball Is Clouded

It is always somewhat disturbing to learn that a group of highly trained and well-payed professionals may not be terrible skillful at their calling. Unfortunately, this is hardly unusual. Similar types of findings could be made for most groups of professionals.

There is, for example, a classic example in medicine. At a time when tonsillectomies were very fashionable, the American Child Health Association surveyed a group of 1,000 children, eleven years of age, from the public schools of New York City, and found that 611 of these had had their tonsils removed. The remaining 389 were then examined by a group of physicians, who selected 174 of these for tonsillectomy and declared the rest had no tonsil problem. The remaining 215 were reexamined by another group of doctors, who recommended 99 of these for tonsillectomy. When the 116 “healthy” children were examined a third time, a similar percentage were told their tonsils had to be removed. After three examinations, only 65 children remained who had not been recommended for tonsilectomy. These remaining children were not examined further because the supply of examining physicians ran out.

Numerous other studies have shown similar results. Radiologists have failed to recognize the presence of lung disease in about 30 percent of the X-ray plates they read, despite the clear presence of the disease on the X-ray film. Another experiment proved that professional staffs in psychiatric hospitals could not take for granted the reliability and accuracy of any judge, no matter how expert. When one considers the low reliability of so many kinds of judgments, it does not seem too surprising that security analysts, with their particularly difficult forecasting job, should be no exception.

Owner of the Crystall Ball. Photo by Elena

There are, I believe, for factors that help explain why security analysts have such difficulty in predicting the future. These are: (1) the influence of random events; (2) the creation of dubious reported earnings through “creative” accounting procedures; (3) the basic incompetence of many of the analysts themselves; and (4) the loss of the best analysts to the sales desk or to portfolio management. Each factor deserves some discussion:

    The influence of Random Events

    The Creation of Dubious Reported Earnings through “Creative” Accounting Procedures

    The Basic Incompetence of Many of the Analysts Themselves

    The Loss of the Best Analysts to the Sales Desk or to Portfolio Management

Burton G. Malkiel. A Random Walk Down Wall Street, including a life-cycle guide to personal investing. First edition, 1973, by W.W. Norton and company, Inc.