Wall Street analysts have gotten a bad rap in the past decade, and for the most part, that reputation is deserved.
They've been accused of promoting stocks to investors of companies that do investment banking business with their firm. And they've been accused of simply being too soft on companies for fear of shutting off the information spigot. Most investors now know that an analyst's opinion about an investment comes with some baggage.
I'm here to argue that the situation works both ways. If you want to understand what an analyst is doing, then you need to comprehend what they're really saying. There are clues to watch for when interpreting analyst speak.
Here's my tips for understanding analyst reports:
1. A upgrade to "buy" or "strong buy" may not necessarily be the case. Look to see what the analyst is doing with the 12-month price target for the stock as well. If the analyst had a price target of $40 on the stock before it was upgraded and only raised that target to $42 with the higher rating, then is it really much different than the "neutral" or "outperform" rating? Maybe the analyst is just trying to curry favor with the company.
2. Watch what the analyst is doing with the earnings per share estimate for the company as well. If they're raising the stock's rating, but not doing anything to their EPS estimate, is there really any new reason to buy the stock? Nope.
3. Understand that in the vernacular of analyst ratings, the only ones you really want to see are "buy" and "strong buy," depending on the terminology used by the analyst's firm. Anything that is rated "neutral" or lower should be avoided at all costs, even if the analyst is writing about the stock as if it's a potential turnaround story.
4. A potential buy could be when an analyst raises the earnings estimates on a company without raising the rating. Let's say an analyst bumps the 2011 EPS estimate for a company he follows from $1.30 to $1.45. If the stock is trading at $15 a share, that means it's now trading at just more than 10.3x earnings instead of 11.5x earnings. The lower the price-to-earnings multiple, the more potential the stock has for rising in the future.
5. Look to see if the analyst owns any of the stock. This is typically on the back page of the report. If the analyst has a chunk of the stock in his or her portfolio, and the recommendation is strong, then that's a good sign that it's a stock you should consider. Also consider holding on to the stock if the analyst isn't selling although they've downgraded the stock.
6. The analyst likely covers a number of companies in a specific industry or sector. Look at all of the ratings for the stocks he or she covers. If there is one or two stocks that get higher ratings than the others, then those are the ones to hone in on when doing your research.
If you're interested in stocks in a specific industry, then find out what analyst is the one that is considered the most influential in covering those investments. Their research reports will likely move stocks more often than other analysts who cover the same stocks.
Happy parsing.