Should We Follow Analyst Recommendations?

New Analyst recommendations come out just about every day for one stock or another. You'll hear various ratings such as: Buy, Hold, Sell, Out Perform, Under Perform, Market Perform, Sector Perform, Strong Buy (Haven't heard this one in a while), Strong Sell, Underweight, Equal Weight, Neutral, Accumulate and a few others.

By looking at this list, you can sort of get an idea of how useful these recommendations may be at times, or at least how easy to understand they are. (Not very easy at all).

To make things more complicated, you'll often find that different Brokerage firms use different ratings. On top of that, one firms "Buy Rating" may not have the same description as another firms "Buy Rating". I've heard a Buy rating issued with a price target just above the current price and other Buy ratings issued with price target 20% above the current price.

This makes it hard to compare one Brokerage firms rating on a stock with another Brokerage firm rating without keeping track of the specific ratings and descriptions each Brokerage firm uses.

I don't know about you, but just trying to write about all the different ratings is complex. Why couldn't they come up with a single rating system so we could understand what they are actually trying to tell us.

Then again, maybe that's the point, to make the ratings unclear and shall I say, deceptive. They wouldn't try and do that though, would they? After all, Analysts and Brokerage firms rating particular stocks don't have any ownership of the shares they are rating, do they? (Sometimes they do.)

I'm sure you have heard sayings about "if someone tells you they have a sure thing about a stock trade that it most likely isn't true". So when you hear Analyst recommendations about a particular stock, don't let your guard down.

Do you know this Analyst personally? Most likely you do not. To help protect your hard earned capital, get used to doing your own research to follow up on specific Analyst recommendations and make sure you agree with the ratings.

Here is an example of an "Downgrade" I came across on a stock that I like, follow and trade personally:

The stock is Jacobs Engineering, symbol JEC. On 05/08/2009 in pre-market trading I noticed a Downgrade was issued by Stifel Nicolaus at 8:46 a.m.

Since I have liked this particular stock for a long trading position (I trade short term, almost always intraday), I wanted to take a further look. I went to Yahoo Finance and took a look at this and previous Upgrades and Downgrades from various Analyst firms.

Next, I wanted to see how accurate the past Analyst recommendations have been from this particular firm issuing the Downgrade. On the chart below you will see the previous ratings issued on this stock by the same firm:

Analyst Recommendations

The first Upgrade on the chart was in November 2006 to Buy from Hold. We'll give them this one but in reality most anyone could have upgraded any just about any stock at the time and been right.

The next rating change came in July of 2007 and it was a Downgrade from Buy to Hold. Any new investors not in on the previous Buy rating would have missed out on a nice move here from $60 up to $100 in less than 5 months.

Next, we move on to August 2008, an upgrade from Hold to Buy. Again, any new investors just getting on board here would have seem a decline of approx. 50% to date and any longer term investors who got in on the initial Buy rating in 2006 on this chart would probably be down as well if they bought more on this Upgrade in August 2008.

So let's see, the most recent two ratings changes by this particular Analyst firm have been wrong both times. Yes, they had one right over two years ago, but who knows if that was even the same person making the call?

The point here is not to single out one particular ratings firm, but to help you understand the importance of doing your own research no matter who is making the recommendation.

I would also suggest to keep a record of various Analyst recommendations and track how accurate their ratings changes are. This way when a new Upgrade or Downgrade comes out, you will know a little better on which ones to trust more than others. Just don't come to trust fully without researching yourself.

A last point I would like to make for this article is that I want you to notice that as the price of JEC went from $35 per share up to $100 per share and back down to below $30 over the 3 year period shown, not once was a "Sell" rating issued. This will be a topic for another article on Analysts.

Return From "Analyst Recommendations" To "Stock Market Research"

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