I realize this is an inflammatory title, but the question is worth asking after their history of egregious conflicts of interest and constant overly rosy views of stocks. Now a new report from Bloomberg backs up those that think analysts are overpaids shills. However, I will argue that they do serve an important purpose for everyday investors.
What Do They Do All Day?
According to Bloomberg, the stocks that were most loved by analysts underperformed the stocks with the fewest “Buy” ratings by an astounding margin of over 2-1. This is somewhat puzzling since analysts are paid millions of dollars and do nothing except live and breate the companies that they cover. They visit factories and meet with the management in order to get the broadest picture available, yet they never seem to get their picks right.
Analysts are classic examples of herd behavior. They very rarely want to stick their necks out and make a call that goes against the grain, because if they are wrong, they will look like fools and possibly get fired. If a stock has 30 analysts following it and 29 tell you to buy it, the last analyst will be hesitant to recommend a sell even if he doesn’t like it for the fear of being wrong. There is clearly safety in numbers in the analyst community and that renders many of their opinions useless.
So what did they get wrong last year? Analysts as a whole were pounding the table on health care names, which underperformed the market over uncertainty about Obama’s healthcare plan. Most did not foresee the passing of the healthcare reform which put a damper on investor sentiment. Bloomberg mentioned that banks were unloved by the analysts, but they staged a strong year as recovery hopes were high.
How Can You Use Analysts?
I believe that “Buy” and “Sell” recommendations by analysts aren’t worth much, but the earnings estimates that they provide can be helpful. Len Zacks, owner of Zacks Investment Research, did a study and found that earnings estimate revisions have a predictive power in determining how a stock can perform. When the average of these estimates is rising, that is a good indication that stock price gains are in store.
There have been many books written about analysts and their conflicts, so I could go on and on, but the bottom line is to take any analyst recommendation with a big grain of salt. If you read analyst reports, pay attention to their earnings estimates, because that is the important nugget buried inside otherwise sometimes biased and useless information.
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