Why Analysts’ Stock Recommendations are SH*T
While I was doing Twitter marketing, I came across this article http://bit.ly/analystssaysell.
From the article above, here is the list of 9 stocks in the S&P 500 that have the highest percentage of ratings in the lowest category.
With large amount of analyst ratings in the lowest category, you would expect all stocks listed above to have a massive declining trend like this:
But in fact, there are more stocks in that list that move like this:
Or even go up dramatically like this:
If you were to short sell the entire list by listening to analyst stock ratings/recommendations, you would have lost everything by now.
Problems in analysts’ recommendations
1. I observe no correlation between buy/sell recommendations and stock movements after recommendations. This observation is also consistent with a blog I wrote on the effect of pundits’ recommendations. https://medium.com/@Nvest/what-you-need-to-know-about-pundits-stock-recommendations-6e45d7ffd121.
2. Analysts never give you timeframes of their recommendations. Analysts only give information on when to enter or to exit a position, never both. Therefore how much you can make from their recommendations is still up to your understanding of stocks.
3. Analysts change their recommendations immediately after massive gains or losses posted. (See WWWW below for example.) There is no value to stock ratings/recommendations when they are only reflecting the current situation.
4. Analysts change their recommendations in order to confirm the existence of a trend and agreeing with other recommendations.
5. All bad recommendations are let go unnoticed while they showcase recommendations they made money on.
6. There are good recommendations out there in the public, but no one knows which ones are good.
Example 1: Groupon
Quality of analysts’ recommendations
If you were to follow experts’ recommendations on Groupon, you would lose all your money by now. Only 2 out of 15 recommendations listed above are correct if hold until today (Stifel Nicolaus 2012 and RBC Capital 2014), and both of them require the investor to short.
Analysts’ marketing timing
Analysts are way off when it comes to market timing. Analysts make buy ratings when stocks have already gone up and vice versa. Because of this, we see that analysts are recommending selling when price is near the bottom and recommending buying when price is already near the top.
Example 2: WWWW
As I am writing this article, WWWW is in its biggest decline.
Let’s take a look at experts’ recommendation to date.
Analysts quickly downgrade their ratings for the stock after the price has already gone down 24%. From WWWW Price target summary, non of the analysts have forecasted its deep decline.
The solution
Although analysts in aggregate don’t generate profitable recommendations, there are still analysts that make stock recommendations that work. When reading recommendations, also be sure to know how well the analyst performed in the past. Just like a resume, the past performances is the best predictor of an analyst’s future performance. The easiest way to solve this problem is to have a system that keeps track of those analysts’ entire performances. Thus, it would allow people to have a better picture of whose recommendations are safe to follow.
Wrap up
Experts’ recommendations are far from best recommendations. In aggregate, their stock ratings and recommendations have no predictability value. However, there are few experts in the whole bunch that make profitable recommendations. When following recommendations, take a step further to check the person’s past performances. Do not blindly follow someone’s recommendations because the person is wearing a suit.
If you have any questions regarding this article, you can email me at fred@nvest.me.
Fred Zhou
