Figuring out exactly what service Wall Street analysts provide for investors (meaning people who think like business owners) has become increasingly unclear to me. Financial theory suggests that a company’s intrinsic value is equal to the present value of expected future net cash flows to the owners of the business, discounted at the appropriate rate; yet in their attempt to serve two masters, most analyst reports explicitly state that the research presented is offering opinions (buy, sell, hold) with the intention of outperforming in the coming 12 months – a goal that leads to a critical question: Are analysts looking for undervalued stocks or catalysts? In the case of a company that’s undervalued, but likely to face short-term issues, what is our equity analyst to do?
The volatility surrounding Best Buy (BBY)'s stock price in the past few months shows just how quickly fundamental analysis becomes a game of follow the leader/stock price. A year ago, BBY common traded in the low to mid $20’s per share; for months on end, culminating at the end of 2012, the stock continued its decline – all the way to a low of around $11 per share. For the analyst needing to make a 12-month recommendation, the recent activity suggested that there was little love for Best Buy – and no reason to suspect that would change. As such, the analysts herded together to present such a view (data presented is from Marketwatch.com):
|BBY Analyst Ratings||Three Months Ago|
Fast forward 90 days, and the market has suddenly become enamored with Best Buy – with analysts being the giddiest of all. With the stock up more than 100% from its lows – lows reached roughly 90 days ago – here’s the current recommendations from the same community (most of the upgrades have come in the past few weeks):
|BBY Analyst Ratings||Today|
This is off a relatively small sample size, but the change is quite clear – from a single analyst recommending Best Buy common stock at half the current valuation a short three months ago, more than one-third of all analysts covering the company now consider BBY a buy.
The analyst group presented has pointed to a couple things in justifying these upgrades, namely a change in management, a 0.9% jump in comparable sales in the fourth quarter, and the company’s willingness to fight back on prices against Amazon (of course this doesn’t address the bigger concern of cost structure – the sole reason why so many are calling for the death of brick-and-mortar, or the fact that many of the company’s product categories continue to show the strongest shift to ecommerce; these questions will likely be saved for when the stock starts to sputter).
This brings up an important question: If analyst estimates are based solely on cosmetic changes or short-term improvements or declines in business trends – with little to no concern about how those changes relate to valuation or the attractiveness of the common stock – then what good are analyst recommendations? How can you be so concerned with near-term price movements – as mandated by their 12-month forecast horizon – yet still focus on intrinsic value?
I guess it will take somebody smarter than myself to circle this square…
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of my portfolio (currently two). In the eyes of a businessman, I believe this is adequate diversification.