Brokerage Analyst Actions – Good for a Laugh? Our media-centric world exposes investors to a slew of information on a continuous basis. Most individuals don’t have the expertise, or desire, to evaluate stocks on their own. They often trust opinions that they see on websites or hear while watching CNBC, FOX Business or Bloomberg channels.
Unless you understand how analysts operate you might think the advice is worth listening to. Researchers want to appear smart when appearing on TV or radio. The best way to do that, in a risk-free manner, is to explain what has already happened. That is much easier than predicting the future.
If a stock has just doubled in price analysts justify the high price while implying they had previously loved and recommended it, when the shares were still cheap. Analysts often put "hot" issues onto their buy lists after they’ve surged. They love to have people see BUY-rated, popular, good-performing tickers on their top stocks list.
Conversely, experts would rather explain why a stock has fallen sharply than defend buying something that has recently cratered in price. Pummeled shares are often bargain-priced but it is risky defending bad looking charts on TV.
Don’t just take my word for this. Here are three examples including Morgan Stanley’s Oct. 29 upgrade on Nike (NYSE:NKE). Their client alert was republished in Barron’s Nov. 2, 2013, issue.
Nike was reset to OVERWEIGHT only after the stock made a new all-time high. After missing the move from $35 to $75, the analyst’s new target price ($85) is a mere 12% above the quote at the time of the opinion change.
Nike’s 10-year median P/E is 18x. The multiple at the time of Morgan Stanley’s upgrade was a 38% premium to that level based on the current estimate for the fiscal year ending next May.
NKE’s valuation appears rich even if fiscal year 2015 estimates prove accurate.
Valuation-based services like Trefis and Morningstar, which rarely appear on CNBC, see Nike as overvalued. Trefis uses a sum-of-the-parts methodology to arrive at a fair value of $60.41, well below the current price. Standard & Poor's figures an almost identical: $60 valuation using a very different technique. Kudos to them for sticking to rational thinking regarding NKE.
Cheerleading for companies making new highs is just one form of bad advice. Pulling BUY recommendations just when previously favored stocks are getting cheap is also common.
Zacks watched good-quality industrial manufacturer Valmont Industries (NYSE:VMI) decline by almost $30 per share before downgrading it from Buy to Neutral.
That call looked good for about 10 days. The shares reversed quickly and are now around $7 above where they traded when the downgrade was released. Investors who listened to the trading alert likely whiffed on the chance to purchase as low as $129.
If you liked VMI at $165 why not love it at $135? If things were really bad, why wait for a big drop before deciding to get out?
Outright SELL ratings are hard to find. STRONG SELLS are even rarer. You might expect to see those only when stocks are sure to plunge.
Water Technology company Xylem (NYSE:XYL) had been cruising along in a range from about $26 to $29 during most of 2013. An unexpected, poor quarterly report was released in late July and the stock fell down to below $25.
Standard & Poor's wasted no time downgrading XYL to their worst-rated category after it was too late for traders to exit reasonably. S&P cut their estimate and price target for both 2013 and 2014.
So did Brean Capital. After the damage was done they changed their rating from BUY to HOLD while saying that fair value was really only $22 to $25. The shares they had advised buying in the upper $20s were now called overvalued at about $25.
In the very short run XYL did decline to under $24. Nobody who gave credibility to the analysts’ words would have dared to buy.
Did these crack analysts get even their strongest conviction play right since that July 30, 2013, downgrade? Xylem reported better than expected third quarter profits last week and ran up to an all-time high of $34.54 on Halloween day. XYL closed out last week at $33.22.
Do your own research to determine whether shares are Buys or Sells. You can’t get paid for what has already happened. In many cases that is all you are learning from changes in analyst recommendations.
Disclosure: Long VMI, Long XYL, No position in NKE.
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