Profit expectations and investment

Quarterly Bulletin 2002 Q4
Published on 16 December 2002

By Seamus Mac Gorain of the Bank's Monetary Instruments and Markets Division and Jamie Thompson of the Bank's Structural Economic Analysis Division. 

This article examines the relationship between expectations of future profits and companies' physical investment. Theory suggests that increased profit expectations should raise share prices as well as investment. But this correlation between investment and share prices may be rather weak if investors' opinions of companies' prospects differ from those of the companies' managers. Using a simple aggregate investment equation, the article illustrates that measures of profit expectations based on current profits and analysts' earnings forecasts appear to be more informative for investment than stock prices themselves. This result is consistent with recent research at the Bank using company data.

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