Researchers Built An AI Model To Predict Stocks’ Earnings Better Than Wall Street. Here It Is.

Feed ChatGPT some financial statements, do some chain-of-thought prompting, and it can give you better forecasts than an investment bank full of analysts.

Back in May, three University of Chicago scholars published a fascinating research paper that tested whether ChatGPT can perform financial statement analysis as effectively as the pros. They found that with some fairly light prompting, the AI sized up those complicated reports and turned them into earnings forecasts that were more accurate than Wall Street’s. These predictions were then used to create model investment portfolios that, when backtested, delivered huge excess returns. The best part: the researchers made their model publicly available. So let me break down how it works – and how you can apply it to your own portfolio.

Thesis

• The researchers fed ChatGPT thousands of financial statements, stripped of dates and company names, from a database of more than 15,000 companies from 1968 to 2021. Each statement was a single input – meaning, no historical context or longer-term firm data was made available to the model.

• They then used "chain-of-thought prompting" to ask ChatGPT a series of questions and get it to predict whether each company’s earnings would be up or down in the following year and whether the magnitude of the change would be small, medium, or large. They also asked the AI how sure it was of its prediction.

• The model’s forecasts were accurate 60.4% of the time, compared to the 52.7% accuracy of professional human analysts’ estimates made one month after financial statements were released. Even more impressively, ChatGPT beat the forecasts analysts made six months after the release, even though those estimates benefited from more timely information.

• The researchers built long-short model portfolios based on the companies for which ChatGPT was highly confident would see big earnings changes. In backtests, those portfolios performed much better than the broader stock market and delivered impressive risk-adjusted returns.

Risks

• ChatGPT can lead you astray. That’s why you shouldn’t use it in isolation when making investment decisions. It’s a useful tool that can supplement, not replace, your own thorough research. Remember: the AI’s predictions were wrong 40% of the time.

• ChatGPT’s accuracy has decreased, on average, by 0.1 percentage points per year, which suggests that it has become increasingly difficult to predict future earnings using only numerical information.

• Earnings forecasts become less relevant throughout the year as companies’ quarterly results get released and as management teams provide short-term profit guidance.

• For certain early-stage companies, what happens to earnings next year is a lot less relevant than the bigger, longer-term outlook of the firm and the wider industry.