Stock Analysts
According to a Wall Street Journal article (February 2012), historical evidence shows stocks with lots of “buys” from analysts do no better than the broad market, on average. Perhaps this is because analysts give 11 times as many “outperform” or “buy” recommendations than they do “underperform.” New research suggests there may be a way to discern which “buys” are worth heeding.
Analysts S&P 500 Recommendations
|
Buy/Outperform |
Hold |
Underperform/Sell |
|
5,800 |
4,480 |
530 |
To form their recommendations, analysts often begin with “discounted-cash-flow” analysis, which uses forecasts of revenues, margins and other factors to determine a fair share price for investors to pay today. Some factors are difficult to measure (i.e., riskiness) while others are impossible to know (i.e., distant growth rates); subtle changes in assumptions can product sharply different results.
The new research indicates that the best recommended changes come from concrete new information, and changes in near-term earnings forecasts are a good sign of such information. The authors of the study calculated that between 1994 and 2007, a trading strategy of buying stocks following raised ratings and earnings estimates and holding for a month, while doing the opposite (short selling) for stocks following lowered ratings and estimates, would have returned more than 45% a year. That works out to several times what an S&P 500 index found would have done.