By Philip Moskie

Every major stock brokerage has its own set of “rankings” that they use to rate stocks. Most brokerage ratings are very similar to one another.  Each firm puts its own spin on the labels they use to brand their own product. Their analysts do their due diligence on a stock and the company it represents, then they assign it one of those rankings. The rankings are usually updated quarterly or when special circumstances warrant it. Special circumstances include such events as a change in the financial health of a company, unusual market conditions and macro-economic conditions in the economy.  

Table of Contents

Introduction

What is a stock analyst?

Stock Rankings

Positives of analyst rankings

The problem with analyst ratings

Case Study

Conclusion

Introduction

Every major brokerage firm employs a staff of stock analysts. The goal is to educate their investors as to the health of the companies they follow. In this article we will discuss the different ranking categories that major analysts use and what the rankings mean. We will also discuss the pros and cons of using stock analysts’ opinions in your investing activities. Finally, we will look at an example of how analysts timing can be dangerously wrong to highlight the risk of using just an analyst ranking to make a purchase decision. 

Please note that it is not the intent of this article to bash Wall Street stock analysts. We are merely trying to educate investors on how to use their work as a tool that they can really use. 

What is a stock analyst?

There are two types of analysts: sale side analysts and buy side. Sale side analysts are those that work for major brokerage firms. They do analysis on stocks they are likely to “sell” their clients. Buy side analysts work for funds and money managers and do analysis that is intended to help the fund managers “buy” in a more effective manner. For the sake of this article, we will be focusing on sell side analysts. Their work is geared toward you, the retail investor.

Each firm has a chosen list of stocks they feel are appropriate for their customer base. Each one of these stocks is assigned to an analyst. Their job is to analyze the company and industry, create a report summarizing their findings and issue their opinion in the form of a ranking.  

Stock Ratings

Here are some examples of analyst ranking categories. These are by no means all the rankings that may be used. These are my descriptions of what the rankings mean. 

Buy: a buy rating is where the analyst thinks the stock is likely to move significantly higher than its current price at the time the report was written. A buy rating is a message to the clients that they should accumulate a position in the stock. 

Sell: a sell rating is where the analyst thinks the stock is likely to lose significant value and that their clients should sell the stock or at least lighten up their holdings a bit.

Hold: a hold rating is where the analyst thinks that a stock is not going to gain or lose significant value soon. The firm’s recommendation is to hold for now. 

Underperform: an underperform rating means that the analyst believes the stock is going to underperform compared to the general market.

Overperform: an overperform rating means the analyst believes the stock will perform better than the market averages.

Strong buy: a strong buy rating indicates that something has changed and that it is going to be very good for the company. This rating indicates some urgency to purchase to take advantage of those circumstances. If the report is three months old, be very careful!

Strong Sell: a strong sell rating indicates that something has changed but is bad for the company. This rating indicates some urgency to get out of the stock before things get even worse. 

Positives of analyst ratings

If you are a long-term investor with a desire to fully understand the stock and company you are investing in, an analyst’s work can be very beneficial. You will never be able to do the level of analysis that they can do. We never discount knowing as much as you can about an investment. We are big fans of Warren Buffet and his value investing. Even if you are a shorter-term investor or trader that focuses on a few stocks to trade, their work can be beneficial. 

Use an analysts work for what it is worth. It’s another tool for you to use in your investing. A word of caution; do not count on analyst projections of where a stock’s price will go. Analyzing a stock in the manner they do is always backward looking. To trade stocks profitably you must be looking at what is happening right now! 

The problem with analyst ratings

One of the biggest problems I find with the analyst ranking system is the fact that there is no consistency between analysts.  One major analyst will say a stock is a buy and another has it as an underperform. This lack of consistency creates another whole new level of decision making for the investor. Now you must underwrite the analysts? As we said this article is not to bash analysts. It is meant to open the eyes of any investor that thinks they can trade and make money based on the analyst ranking system.