The case FOR analyst reports 1 comments
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Should we rely on recommendations from analyst reports to make our decisions (what stocks to buy, what action to take on our existing holdings)? The simple answer is no, since broker opinions are perpetually ridiculed by most investment writers and gurus such as Warren Buffett. Yet, is there really zero utility that we can extract from these reports?
The case against analyst reports is well known to most who are in the investment game. The analysts are from the sell-side ie. they belong to brokerages whose job is primarily to market securities. As it is for most salesmen, their bias is towards promoting the good side of their product, in this case shares. Conflict of interest is also created when their brokerage owns the stock. Further pressure on the analysts to issue favourable stock reviews is created when they rely on the companies they cover for a lot of information and hence do not want to anger them unnecessarily.
But I have often found such reports useful in a number of ways.
Firstly, the analysts' full-time jobs is sector and stock research so they typically manage to unearth more useful information about the company than a small-time investor can on his own. I find that reports covering company visits by the analysts are quite informative on issues like capacity utilisation, management outlook/updates etc. The trick is to separate the useful facts from the opinions. The corroboration of facts mentioned in an analyst report with other evidence eg. another analyst report, or news available elsewhere, will serve to validate the information.
Secondly, when an analyst initiates coverage of a stock it signals that this stock might be starting to ignite institutional interest. I find that this is especially the case if the brokerage issuing the report is a foreign broker, as they serve the big foreign money. And when the big money starts to nibble at the stock, you can be sure that price rises are sure to follow.
Thirdly, analyst reports quite often lead to price rises. You certainly want to be on the leading end of the buy orders, and in fact many institutional funds base their buying strategy on having early availability to which stocks are going to be upgraded by analysts. This creates a problem for the small investor because when the report is made available to him, his buy might coincide with the sell of these institutions who bought earlier. Yet there are many stocks which have exhibited price rises long after they were upgraded. Maybe the broker recommendations should only be selectively taken in by the investor; he can treat the broker as having done an initial stock screening for him to narrow down his search; further decisions to zoom in to a particular stock need to be made subsequent to more personal reading up and examination of the company's past records and fundamentals.
Fourthly, the target prices issued by the brokers often serve as some kind of upper cap to how much the stock price can go in the medium term. If the target price adjusts too fast, I will often take it as a warning sign unless the fundamentals for the stock has altered significantly.
Last but not least, reading the reports can provide a good education for the new investor. These reports are prepared by people who have been in the investment trade for some time and who are typically obsessed with stocks; the investor can see how they analyse the stock from different angles and using different valuation methodologies. Definitely more practical and useful than reading theoretical models like the Capital Asset Pricing Model.