Understanding Analyst Ratings
and When to Ignore Them
Analysts from the major brokerage houses are primarily in the business of fortune-telling. They research stocks, analyze the charts and fundamentals, and then make recommendations on whether to buy, hold, or sell. At the same time, they issue predictions as to what the stock's EPS and share price will be for the next few quarters. The company itself may also issue predictions about future quarters' EPS and share price, although the company predictions and analyst predictions are not always in agreement.
These forecasts take on tremendous importance to traders and to the company being traded. If the general consensus is, for example, that the next quarter's EPS will come in at $1.00, but it comes in at only 90 cents, the share price is likely to drop. Corporations are under pressure from the entire analyst and investment community to meet these short-term expectations, and often must make decisions that are more geared towards these short-term goals as opposed to taking a more long-term and strategic approach to business that would ultimately be better for everyone concerned.
There are also some inherent conflicts involved when brokerages provide investment banking services to corporations, and this is perhaps why there are far more "buy" recommendations out there than there are "sell" recommendations. Nonetheless, the analyst's opinion does contain a lot more than those single words, and their detailed research can be very valuable in helping an investor reach a sound decision.
There are many anecdotes about investors who follow analysts' advice rigidly and end up losing big-time, and generally it's good to keep in mind that these are merely opinions. Take them for what they are worth. The analyst opinions should always be a part of your research before buying, but not the only research--your own opinion matters just as much as those of the analysts. Nonetheless, the analyst opinions have value simply because they set the tone for the market demand of a stock. Even if the analyst is completely off base, the simple fact of the matter is, their opinion has been made public and they have set up an expectation on the part of the investing public. Stocks rise and fall because of expectations as much as they do in response to fundamentals. As such, it's entirely possible for an analyst opinion to cause a good stock to take a dive, or a bad stock to spike.
Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.