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The Analysts Analyzed: Part 3

Something else I like to look for is how many analysts are covering a particular stock. Even if there is a lot of coverage and they all have buy ratings on it I would not buy a stock based on that alone. Why Because if there is a consensus that the stock is a good buy then there is a good chance that it is already overbought. In other words the important money managers and institutions who can move the stock price up with the volume used to purchase their positions are already in the stock.  If this is the case there are no big buyers left. 

So if we do not want to buy stocks with buy ratings what do we look for Here is an interesting way to look at things. If you are a longer term investor start by looking for stocks that have neutral ratings by big firms like Merrill Lynch and Goldman Sachs.  If they are still following the stock it means they are still interested in the company's story. If so there is always a chance they will upgrade it later.  They still have hope for the company or else they would drop coverage altogether.  Sooner or later they may put the stock back on the buy list with an upgrade. This of course will drive the price up in the short term. 

And remember this by the time they get around to upgrading a stock you bet they have accumulated all the shares they want before the upgrade.  Chances are the stock you bought while nobody liked it has risen in a steady uptrend for awhile while the slow accumulation occurred.  And when the upgrade comes you should probably sell at least half of your position because you can bet the analysts firm is also selling into the upgrade dumping some of the shares they accumulated on the cheap while they were not recommending the stock.  

Brokerage Rating Systems
You must make sure you understand the rating system used by each brokerage.  For example unless you are familiar with the scale used by Goldman Sachs it may not be obvious that a market outperform is not such a good rating.  It actually ranks third best in their ranking system behind recommend list and trading buy. 

Lastly there are not many sell ratings in the analyst's community but when one finally does come out it has lasting effects on a stock.  The effect of a downgrade to sell will last much longer than the impact of an upgrade to a buy.  In other words you can buy a stock a few days after the upgrade because the effects of it have worn off and the stock has settled back down. But when there is a downgrade to sell you never ever buy that stock. This is the only time I would ever listen to an analyst.  When they say to sell you must sell.  The negative effects of a change in a rating to a sell tend to linger for a long time and the chances are good that the stock will continue to drift lower in an extended downtrend for months or even years. 

The bottom line is when the rating changes for one of the stocks you follow you will be faced with the task of trying to figure out what to do.  Unless you are a premier client chances are a lot of people have heard the news before you and unfortunately the price will have already moved by the time you find out about it.





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