Article Spotlight

 

In this series we analyze current financial articles and explain how the conclusions of the article relate to our investment strategy.

How Accurate Is Wall Street Research?

Deciding when to sell an individual stock can be challenging; some rely on technical indicators, some on gut feelings, while others consult Wall Street analyst ratings.  However, all of these methods are fraught with pitfalls.  One of the mains problems with investing in individual stocks based on published research is the reliability and integrity of the research provided.

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A recent example of this phenomenon is the ratings for BlackBerry (Ticker: BBRY), the company formerly known as Research In Motion (RIM).  While they were once a pioneer in the smart phone industry, BlackBerry has been struggling lately. You don’t need to look any further than your pocket or the hands of those around you to see that there are not many BlackBerry devices remaining.  It would be hard to come up with a compelling story that described BlackBerry as anything but a company on the decline.  However, this did not stop Zacks Investment Research from giving BlackBerry a 3.68 rating this past Monday.   Zacks uses a five-point scale where 1 is a strong buy and 5 is a strong sell.  While this rating is not exactly a ringing endorsement, it qualifies as a “hold,” suggesting that investors holding BlackBerry should continue to do so.  This rating seems to underestimate BlackBerry’s recent struggles, as highlighted by the fact that on September 23rd they announced a deal to go private by agreeing to a buyout with another firm.

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This is just one example of seemingly inaccurate ratings.  What happens if we looked at the buy-hold-sell ratings for all companies in the S&P 500 Index?  Looking at 11,000 ratings S&P Capital IQ assembled from Wall Street analysts, 93.5% of the ratings are hold or higher with 48% of those ratings marked as a buy or strong buy. Those ratings seem very statistically unlikely.

To understand these ratings a bit better, it is instructive to examine the source of most published research.  Most investment research reports and analysis are produced by what are known as “sell side” firms.  These are companies that are involved in the analysis and sale of securities, such as investment banks and broker/dealers.  Sell side firms employ large numbers of analysts and produce vast quantities of investment research ranging from reports on individual companies to analysis of the global economy.  This research provides the basis for many active investors, individual and institutional alike.  However, when using outside research, one should always first consider the source of that research, and the incentives of the analysts involved.  Sell side firms depend on big corporations for a large amount of their business, particularly through investment banking services.  Unfortunately, this can cause a conflict of interest, as corporations are reluctant to do business with a firm that has produced negative research on their company.  As a result, sell side ratings tend to be much higher than would be expected in an efficient market, as shown in the S&P 500 example above.

Instead of trying to pick individual stocks based on ratings that may be biased or flawed, we recommend a time-tested approach.   Working with an advisor to help you achieve your goals while keeping you diversified using enhanced-index funds has yielded much better results than relying on “expert” analysts.  When investing for something as important as your financial future, it is critical to take your advice from someone whose goals are aligned with your own, and not from those who depend on the goodwill of those whom they evaluate.

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About Shan Zubair

As a financial advisor, Shan works closely with his clients to help define and commit to their retirement and investment objectives. Shan is a Certified Financial Planner™ and Chartered Mutual Fund Counselor (CMFC®).

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