Should You Notice Analyst Stock Ratings?

I think you should and I especially think you should pay attention to the ratings from analysts at big investment banks.  I am not so sure about the independents, Morningstar and Value-Line for example.  Ultimately it depends on what you want to achieve with your portfolio.

If you are a long term investor with minimal short term concerns, then the independents may be useful for you.  If you are more interested in the short to intermediate term then the investment bank analysts may be more for you.  They can help you and not because they are usually right.

Consistently wrong is just as valuable as consistently right.

The independents need to be right or they will eventually have no subscribers. They are motivated to be right. Inconsistent won’t work. They will be more objective and likely more careful.

On the other hand, investment banks make money from fees resulting from mergers, acquisitions, new stock issues and advice.  The analysts support those functions, they do not lead them.  The investment banks make little or nothing from selling their analysts’ advice.  No investment bank analyst will ever publish a negative report about a fee paying  client company and likely not even about the industry.

The result: bank analysts tend to drive stock prices either up or down depending on their intent.  The meaning of the report is closely linked to the needs of the institution, not to your needs.  In addition, these analysts tend to stick with a position longer than you or I might.

You should assume that the bank analyst report serves some purpose other than objective study and advice. If the bank earns significant fees from the subject company, you should be cautious in following their advice.

Better yet, trade against their direction.  For example a stock that has been materially downgraded and whose price has fallen may be a good candidate for purchase.  One that has risen sharply may be a good short.

You can never assume that these analysts are always wrong but over time you will find that trading in opposition has potential.  If nothing else, their downgrades may provide a signal that identifies what you can look at profitably.

All short to medium term trading has risk.  It has less if you understand that not all of the information presented to you is complete and objective.

The analyst provides meaning that is likely different than what you need for sound investment decisions. It is still useful once you adjust for the bias.

Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. Contact: 

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