Investors that would never think of taking a gamble on a “hot stock tip” overheard on a discussion forum or elevator routinely fall victim to another common fallacy: Believing everything they read as long as it is cloaked in the shroud of an “analyst report”.
What is this Analyst Report?
Analyst report stock recommendations based upon “Buy”, “Sell” or “Hold” ratings after reviewing the current market conditions, company issued statements and a host of other criteria.
Sounds easy enough – let the experts do the research and allow informed investors to act on the information; after all, analyst reports can cost hundreds or even thousands of dollars depending upon the provider.
Pitfalls of the Analyst Report
Indeed, analyst reports are useful tools particularly if issued by well known brokerage firms or other institutions however, even those have limits:
- By the time the average small investor has an opportunity to obtain a copy the information has been widely dispersed and acted upon.
- Furthermore, analyst reports are only one small segment of the investment picture and should not be used in isolation.
- Finally, analyst reports are only as good as the original research. This final point is where most novice investors go wrong.
Yes Men?
Don’t believe everything you read. Research has repeatedly found a disproportionate level of “buy” recommendations compared to “sell”. In fact, the ratio is nearly 50 to 1 in favor of “buy” recommendations.
By definition, since only half of all stock can perform better than average, the number of “buy” versus “sell” recommendations should be close to equal.
Researchers decided to find out what fuels this overtly optimistic trend among investment analyst and found the increase in “buy” recommendations closely correlate with the stocks underwritten by their employer or firm.
Take Precautions
Use caution when reviewing analyst reports by following these simple tips:
- Read reports by authoritative analysts with proven track records.
- Use analyst reports as one segment of your own personal research. They can provide valuable insight into the current climate of the corporation.
- Have your own strategy and understand the fundamentals before investing.
- Tame the claims. Take anything less than a “strong buy” with a grain of salt.
- Don’t make decisions in isolation; read reports in conjunction with your own research.