Tuesday, January 11, 2011

Stock Analysts and Forecasts

“Isn't it interesting that the same people who laugh at science fiction listen to weather forecasts and economists?”


I posted a note yesterday discussing the perils of using longer range forecasts to make investment decisions.

As it turns out, even analysts - who presumably spend all day, every day - thinking about the stocks that they follow are also fallible.

Yesterday Bloomberg carried a piece describing the results of a study of Wall Street analysts (tip of the hat to loyal reader Bob Quinn for pointing the piece out to me):

Companies in the Standard & Poor’s 500 Index that analysts loved the most rose 73 percent on average since the benchmark for U.S. equity started to recover in March 2009, while those with the fewest “buy” recommendations gained 165 percent, according to data compiled by Bloomberg. Now, banks’ favorites include retailers and restaurant chains, the industry that did best in last year’s rally and that are more expensive than the S&P 500 compared with their estimated 2011 profits.

Analysts Prove Hazardous as Contrarian Stocks Surge (Update3) - Bloomberg.com

This is not, by the way, to necessarily trash the Wall Street community but rather to point out how difficult it is to make good recommendations that will deliver superior investment returns relative to the market.

The article carried the following quote which encapsulates the problem:

“When you have a stock that has 15 analysts covering it and it has 15 buys, I can’t imagine it has much outperformance left,” said {Don} Wordell, whose $1.64 billion RidgeWorth Mid-Cap Value Equity Fund topped 98 percent of peers in the past five years. “You’ve got a stock that has 15 sells on it, you’re set up there to have some strong outperformance.”

It seems to me that the value of Street analysts lies in the access that they typically have to management and other industry leaders. In my opinion, you don't use the Street's "buys" or "sells" for investment decisions but rather as a good source of scuttlebutt which helps you think about a particular sector or company.