Have you ever played Bingo? This game of chance is a bit like trying to follow analysts’ calls on stocks.
One Australian research house helpfully offers investors a list of all the stocks in the S&P/ASX 200 index alongside their key financial variables and a summary of the recommendations on each stock from seven major broking houses.
When scanning this document, multiple variations of “buy”, “hold”, “sell” for each stock spill across the page in a tiny font that sends even the keenest-eyed reader into head-spinning confusion.
For instance, retailer Woolworths was rated a buy by one analyst, a hold by two others and a sell by the remaining four. Private hospital group Ramsay Health Care was rated as a buy by two analysts, a hold by three and a sell by two.
In the materials sector, there is a similar level of divergence. BHP Billiton was rated a buy by three analysts, a hold by another two and a sell by the remaining two. Among the banks, ANZ had three buys, three holds and one sell.
What’s remarkable is the lack of consensus on the list. Recommended buys and sells frequently balance each other out, or the difference is split among holds. Commonwealth Bank has two buys, two sells and three holds, for instance.
The table below shows recommendations for some of the most popular stocks from seven broking house analysts, as of June 2016.¹
One of the few stocks to have unanimous buy recommendations was poker machine maker Aristocrat Leisure. Its stock recently hit eight-year highs and its price has risen six-fold in five years. But does that mean it will continue rising? Obviously the analysts are confident. But what happens if there are regulatory changes in the gaming industry or a competitor overtakes it or it loses key personnel?
These are idiosyncratic risks related to one particular company and industry that no analyst can quantify. The price of the stock today reflects what we already know, but we can’t account for what might happen in the future.
Ultimately, analysts’ calls are only opinions about a stock’s prospects. That there are differing opinions about securities is not surprising given analysts will use varied methodologies and put more or less weight on different risks and variables.
Fortunately for end investors, all those opinions are public and already reflected in the prices of stocks, which represent the collective view of market participants about a company’s future cash flows. Are you going follow the collective view or that of an individual? The risk of doing the latter is that few people consistently get it right.
So what are we to make of all this?
- Firstly, analyst’s recommendations can vary enormously for single stocks. If you were to base an investment strategy on these recommendations, whom would you follow?
- Secondly, what advisor has the time or the inclination to base their clients’ investment strategy on scanning analyst’s recommendations for each and every stock? And, in any case, how can we tell to what extent the ratings are already reflected in prices?
- Finally, why not base your strategy on the information already available in prices? We have seen that this reflects the aggregate opinions of all participants, whether bullish, bearish or indifferent.
Our evidence based Enhanced Asset Class Investing approach is based on the science of capital markets. Decades of academic research from Nobel Laureates and leading researchers around the world guide the way.
You can scan as many lists as you like, but investment really shouldn’t be like a game of Bingo.
¹Analyst Recommendations, Mason Stevens, June 2, 2016