Consider analysts’ recommendations and their target prices when picking individual stocks to buy. If you do not remember anything else about analysts’ recommendation, always remember that they are not your friends. They are not on your side, the side of the small individual investor. They do not work for people like you and me. Take what they say with a grain of salt. So you might be asking, “Why even listen to them at all?”
Don’t get me wrong. I do look at what several stock analysts say about a stock I am considering buying. You can find out many of their buy/sell recommendations and their one year forecast for the stock price at Yahoo Finance, Google Finance, The Street.com, Fool.com, and a host of other sites. Those four sites just happen to be my favorites and the ones I personally use. One reason to consider what they say is because of their focus. Analysts spend a huge amount of time researching just a few select stocks that they specialize in. They follow their respective stocks with a vengeance and are among the first to know when things at the company are going well or poorly. Many times they are in constant contact with company executives.
But, despite their intense company knowledge, there are a few reasons to be cautious. Analysts conduct 95% of their business with institutional investors, such as mutual funds and pension plans, and with corporate executives. Analysts are not impartial. Most are bound to promote the stocks their parent investment company is conducting investment banking business with. Less than 5% of all their recommendations are to sell a stock.
Many recommendations of analysts are skewed like Army evaluation reports, where everything is rosy and the Soldier in question is the best thing since sliced bread. Stock picks by professional analysts are skewed to the right the same way. Most analysts’ recommendations are buys or neutrals. What you should really watch out for are the changes. Even a downgrade from a buy to a neutral is a strong signal to the average individual stock investor to sell. Do not be fooled by changing names. An under perform rating is exactly like an old sell recommendation just with a nicer name and better connotation. Analysts run in a pack. Keep an eye out for the one or two analysts who go against the grain of the market’s conventional wisdom. They are usually early predictors of a stock price’s movement.
Just remember what John Kenneth Galbraith said, “There are two kinds of forecasters. Those who don’t know and those who don’t know that they don’t know.”
Disclaimer: Don’t forget that most of your investing for retirement should be through good growth stock mutual funds. I recommend only invest in individual stocks with a small amount of “fun” money.
Stay tuned for more in our six part series on picking individual stocks. Next time we will talk about insider trading. I’ll show you how to do it the legal way so we call stay out of jail and earn some money.
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