Based on a company’s sales and earnings per share growth over the past 10 years, an analyst has concluded that its high rate of growth will continue in the future.
Can this be a hot hand fallacy because he expects the share price to go on increasing?
I’d consider it to be naïve extrapolation.
What’s their answer?
This is the whole question and the answer quoted exactly as given in the curriculum:
Analyst Case Study
Based on a company’s sales and earnings per share growth over the past 10 years, an analyst has concluded that its high rate of growth will continue in the future. Before the report is completed, the analyst reads in a newspaper that the company’s chief executive has made an apparently very profitable personal investment in another unrelated business. The analyst believes that this profitable outcome is evidence of the chief executive’s entrepreneurism and dynamism, and that it is additional confirmation of the analyst’s assessment of the company in the report. Supported by the additional information, the analyst now feels more confident with the forecasted growth rates and in fact increases the average forecasted earnings growth rate and decreases the dispersion of the forecasted growth rates. He includes the additional information about the chief executive in the report.
Discuss flaws in the analyst’s approach and possible biases of the analyst.
Solution:
The value of the additional information is difficult to quantify, and it may not have been collected systematically. The analyst may not have looked as rigorously for evidence of how representative the successful investment was among the chief executive’s total portfolio of personal investments; other investments might have shown poor returns but received less publicity. Newspaper coverage can be selective. Thus, the new information might reflect availability bias. The chief executive may even have been motivated to diversify his investments by concern about the outlook for the company’s stock. The analyst’s judgment might have been adversely affected by overconfidence, with faulty reasoning contributing to the issue. Further, the analyst might have seen the additional information as being representative of a mental picture of the characteristics of a growth business.