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Why You Should Ignore Analyst Ratings for These Stocks

December 29, 2010 | About:
Street Authority

Street Authority

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Most investors take a look at them before they leap into stocks, but analyst recommendations don't necessarily have a great track record. So, before you take a buy/sell call on faith, you may want to consider the fact that the folks doing the ratings aren’t always right. But that's not the end of the world for investors. In fact, I've found two stocks where you can beat the crowd and scoop up their shares before the analysts notice and other investors send the price soaring.

Pretend you were an analyst who had downgraded a stock to an "underperform" rating in April of this year only to see that stock rally 117% during the next eight months. Would you be expecting a big year-end bonus? Probably not.

By the same token, if you didn't upgrade that stock to an "outperform" until October of this year -- well after the stock's price had tripled -- wouldn't you say you missed the boat and were simply chasing performance?

The thing is, those weren't hypothetical scenarios. That really happened for Netflix (NFLX) in 2010. Though a few analysts gave the company the appropriate rating at the right time, a whole slew of downgrades were issued this year. Meanwhile, Netflix shares cranked out their 223% gain and flew right through the majority of pessimistic expectations.

To be fair, Netflix seems a bit frothy with a trailing price-to-earnings (P/E) ratio of 67.2 and a projected P/E of 46.5 for 2011. Perhaps that lofty valuation was what worried professional stock-pickers into a bearish stance. On the other hand, the reason for the analysts' whiff is irrelevant. These professionals are paid to spot rising stocks and to steer clear of falling ones. Yet Netflix threw most of them for a loop this year. Investors would have been better off on their own, just following the trend.

It works the other way too. Wall Street's brightest minds are just as capable of going down with a sinking ship, chanting "it’s bullish" the whole time.

Credit Suisse Group (CS) is a prime example. Its stock was upgraded to a "buy" in July of 2009, after it had rallied more than 100% off its bear market lows. True, Credit Suisse continued to move higher through the end of 2009. However, it started to move lower at the beginning of 2010, eventually falling under the price seen at the time the "buy" rating was first issued. To this day, analysts still haven't budged on its stance even though the company's stock is now in the red by 23%.

It would be amiss to say every analyst misfired on Credit Suisse and Netflix -- they didn't. In fact, an "underperform" rating was posted on Credit Suisse at about the same time the 2009 "buy" rating was issued. The problem is, which advice were you supposed to follow if the calls were diametrical opposites? The lesson learned is simply that analysts, despite their fat paychecks, may be no better than a coin toss… which is actually good news if you own or were mulling a purchase of insurer Platinum Underwriters Holdings Ltd. (PTP) or computer peripheral maker Synaptics Inc. (SYNA). See, neither stock is feeling the love from Wall Street's stock-pickers right now. Platinum Underwriters is currently rated barely more than a "hold" call (and practically a "sell" in this bullish-biased aspect of the business). Synaptics is rated even lower, with the bulk of the opinions on Synaptics also being mere "holds."

So what? It's odd because Synaptics blew right through the recession like it wasn't even happening, earning more per share every single year since 2006 (including this year, and probably next year as well). And, priced at only 12.4 times trailing earnings, it's not like valuation is an issue. The really odd part here, however, is that analytical teams have actually updated their opinions on Synaptics recently, specifically going out of their way to downgrade the stock to a "hold" rating.

Platinum Underwriters is less followed, with only four research firms tracking its performance on the stock market. None of those opinions have been updated since April of 2009. Yet, with a single-digit P/E on a look-back and look-ahead basis being underscored by 30% net margins, and a 12% growth forecasted for the coming year, you'd think analysts would be steering investors toward it.

Action to Take --> Sometimes analysts are right and sometimes they're wrong. Either way though, they're often poorly timed. Credit Suisse and Netflix both verified that reality. In almost all the cases where analysts were wrong, the obvious and common-sense clues came out of the woodwork after the fact. That's why instead of following analysts' opinions of them, the time to have faith in Platinum Underwriters Holdings and Synaptics Inc. is now, before the rest of the market figures it out and gives them the proverbial green light.



-- James Brumley

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