Sunday, November 27, 2011

What good are Wall Street Analysts anyways?

By Rajiv Hargunani

Turn on the TV or pick up the newspaper/magazine and you will hear Wall Street Analysts touting Strong Buy/Strong Sell recommendations on a particular investment.

Generally speaking, the analysts have ratings that go something like Strong Buy, Buy, Hold, Sell and Strong Sell. I for one have never been able to determine what is the difference between a Strong Buy and a plain normal Buy. To put it in simple terms, a Buy (Strong Buy) rating would imply the analyst is bullish on the investment i.e. they see the stock heading higher from its current price over the specified time horizon. A Hold rating means that the stock price probably won’t move much in either direction and a Sell rating would mean the analyst has a negative view on the stock and expects the price to be lower over the time period.

Most individual investors are easily influenced when they hear words like “extremely undervalued” or “overvalued” used by the analysts even if they don’t know anything about the company being discussed. How many people will actually go through the analysts report after the call is made and read the report to understand it? Maybe, we believe them assuming that the analysts have done their homework and blindly trust these so-called experts; in other words we are too lazy to do the homework ourselves.

The way I look at it, the best possible use of any recommendation is a data point to aid us in our own research and nothing more. We don’t know what the ‘expert’s” bias is... we don’t know if they have a position in the investments before espousing their opinion.  For the most part, we don’t even know their track record of how right or wrong they have been. I am certain a Google search on these experts would reveal a more realistic image

It is hardly shocking that most experts have a bullish (buy) rating on a majority of the investments. Have you ever wondered why? Have they not learnt from the dot-com debacle where anything that had a .com behind their name got a very bullish rating? The belief, that the internet would unleash a new economy, caused most experts to ignore time-tested fundamentals and get sucked into the hype surrounding the internet. Just like all previous bubbles, the dot-com bubble busted. Sadly, the casualties were hardly these so-called ‘experts’, mostly they were folks like you and me. For example, In June of 2000 Pets.com had most analysts rate it a buy even though the stock was down more than 80%. What gets me even more perplexed is to see/read/listen to these same experts still talking the same language. Fast forward today and look at MF Global. We had a few analysts who had a buy rating in the days prior to the company filing for bankruptcy.

Here are my thoughts on why the analysts are so off base

1. On the bullish side, they stick to names that have the momentum and try and ride that name to success.
2. In some cases, they are riding on the success of one or two calls made in the past which gives them the unofficial title of the “expert”
3. There is a tendency for these analysts/experts to stick to their bias (bullish or bearish) regardless of the evidence being presented.
4. There could be a conflict of interest between the bank/brokerage firms the analyst’s works for and the relation the banks have with the company. These financial institutions generate a lot of revenue from offering services to these companies. The analyst may feel “pressure” to come out with a report that does not jeopardize this relationship.
5. On the pessimistic side, The “End of the World” callers have been with us forever and we are still here. Very few such calls have ever come to pass.
6. There is very little accountability to what they have said.

So what is an investor to do?

1. The analyst/expert does not know your financial situation, so taking action on what they suggest without doing your homework is asking for trouble.
2. Try and get a historical record of the accuracy of this analyst.
3. Determine if this analyst has pre-disposed bias, either bullish or bearish. If the weight of the evidence points to a contrary opinion, that would be a red flag.
4. If you decide to take action on some recommendation, make sure you have an exit strategy.
5. Determine if the idea being suggested fits your risk profile. If it does, then look at your portfolio and see if you have a similar investment. You want to make sure your portfolio is diversified. For example, adding names such as Exxon and Chevron, both in the Oil/Energy sector, does little to reduce volatility in your portfolio.
6. Pay more attention to the earnings, dividends & cash flow of the company. Look at the big picture i.e. the economy for clues. We get a slew of economic reports, such as Retail Sales, Industrial Production, Payroll data, Manufacturing numbers, Inflation numbers every month, so start tracking some of these. Try and correlate the economic numbers to the companies you are following. Nothing beats doing your own research and gathering the facts.

So the next time you hear “Buy Buy Buy” or “Sell Sell Sell”, learn to filter out the noise and pay attention to the facts. You are more likely to succeed doing your own homework.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Rajiv Hargunani and not necessarily those of RJFS or Raymond James. Raymond James Financial Services, Inc., its affiliates, officers, directors or branch offices may in the normal course of business have a position in any securities mentioned in this report. All stock prices are quoted as of _11/21/2011. Exxon Mobil (XOM) closed at $76.91 and Chevron (CVX) closed at $95.66. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Diversification does not ensure a profit or protect against a loss. Past performance may not be indicative of future results.

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Recent posts by Rajiv Hargunani:

• Does Dollar Cost Averaging Work?
• Dividend investing tips
• Recovering From Large Investment Losses
• Inflation: What it means & how to protect our investments
• Emotional Investing: How Fear & Greed can impact your bottom line
• Early Distributions From Retirement Plans

 

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