Analysts Are Wrong About This Stock

I am going to tell you about a stock that analysts are completely wrong about.

Before I reveal it, though, let me set the stage with a cautionary Wall Street tale. I warn you, it may make you angry.

As reported by The Wall Street Journal, Brian Kennedy is a Wall Street analyst who nailed a "sell" call back in April. He saw bad things ahead for CardioNet -- the maker of a wireless heart monitoring system. Specifically, based on his research, he expected Medicare to heavily reduce the price it paid for CardioNet's system.

He was spot-on. Less than three months later, Medicare made its price cut and CardioNet shares plummeted. Kennedy's April warning saved his followers a 70% loss ... during a bull rally, no less.

His call looks great now, but at the time, all he got was:

  • Ridicule from competing analysts.
  • Hostility from co-workers.
  • An internal legal investigation.
  • An SEC complaint (filed by CardioNet).

He would enjoy being proven right and getting the last laugh, except for one thing. Realizing that "there is no real desire for that kind of report on Wall Street," he quit his job at Jefferies & Co. in July.

The why behind the why
You would think that a guy who could think independently to save his clients a fortune would be exactly the type of guy you'd want to keep around.

I know I would want him around. I know my colleagues at The Motley Fool would as well. And I'm sure you would, too.

But Wall Street? Not so much.

Yes, they want to please their clients. But not at the expense of ticking off other, more lucrative clients.

You see, Wall Street firms don't just make "buy, sell, or hold" calls on companies. They also underwrite the IPOs and secondary offerings of these very same companies. This is in addition to debt underwriting, mergers and acquisitions advising, and anything else they can charge for.

Sure, "Chinese walls" and other precautions help, but it's simply not in Wall Street's best interest to criticize a client.

Now, this wouldn't be quite as big a deal if Wall Street wasn't so incestuous. When a company goes looking for capital, it's not just one firm that helps it out. Nope, Wall Street forms a syndicate. When Google (Nasdaq: GOOG  ) went public in 2004, 28 Wall Street firms underwrote the IPO, including Morgan Stanley, Goldman Sachs, JPMorgan Chase, and on down the list. When Visa (NYSE: V  ) went public in 2008, 45 underwriters were on board.

Since the gravy train only starts with a company's IPO, you can see how there are incentives to rate a company a "buy" or at the very least a "hold." And don't be fooled. Companies know who's been naughty and who's been nice. You can go back to CardioNet's SEC complaint against our intrepid analyst for proof of that.

Here's how bad it is
Recent data from Thomson Financial gives us an idea of just how blatant that "buy" rating bias is -- analyst buy calls outnumber "sell" calls almost 7-to-1.

For a more ground-level feel, let's begin at the beginning. Here are consensus ratings for 10 of the largest S&P 500 stocks starting with the letter "A":

Company

Market Capitalization
(in Billions)

Consensus Rating

Apple (Nasdaq: AAPL  )

$188.3

Buy

Abbott Laboratories

$83.9

Buy

Amazon (Nasdaq: AMZN  )

$60.4

Buy

Amgen

$58.2

Buy

American Express (NYSE: AXP  )

$48.6

Buy

Apache

$35.1

Buy

Anadarko Petroleum (NYSE: APC  )

$31.5

Buy

Aflac

$22.0

Buy

ADP

$21.8

Buy

Archer-Daniels-Midland

$20.3

Buy

Source: Yahoo! Finance.

In fact, when you go through the entire S&P 500, there are only four companies that are so bad that they are consensus "sells."

Analysts are wrong about this stock
Believe it or not, one of these four is Hershey (NYSE: HSY  ) . Yes, you can criticize Hershey for being closely held, for stagnating growth, and even for being a little pricey.

But the fact remains that Hershey has a 42% share of the stable U.S. chocolate market, is pumping out cash flows that are much higher than earnings, has a strong balance sheet, and has a sustainable 3.3% dividend.

In short, it's utterly ridiculous that Wall Street thinks Hershey is one of the very worst bets out of the entire S&P 500.

It's thinking like this that gets me fired up to research stocks and take on the market. It's also what spurred David and Tom Gardner to start The Motley Fool in the '90s. In March 2002, they took it a step further by starting their Stock Advisor newsletter.

Each month since then, David and Tom have each picked one stock they consider a "buy" and have combined to beat the market by an average of 49 percentage points per recommendation. If you'd like to join them and see all their picks, click here for a free 30-day trial. You can cancel at any time.

Anand Chokkavelu does not own shares in any company mentioned, but has been thinking about a Kit Kat bar since the first mention of Hershey. Google is a Motley Fool Rule Breakers recommendation. Apple, Aflac, and Amazon.com are Motley Fool Stock Advisor choices. Automatic Data Processing is a Motley Fool Income Investor selection. The Fool has a disclosure policy.


Read/Post Comments (8) | Recommend This Article (35)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 23, 2010, at 10:53 AM, Owens7301 wrote:

    I am 60 years old and have traded stocks since high school. This article could not be any more accurate. All you really need to do, to seriosuly believe in what is said in this article, is to have worked in a corporation where you truly see how it works. "Yes Men", that kiss you know what, are there at all levels and saying or correcting what is said gets your in a "rat-hole." I have been there, said what was right, corrected the CEO that "sales" do not beget strength unless they end up on the bottom line, and the company is bankrupt...a $10 billion + company. Believe and propsper...do your own research and trust your own instincts.

  • Report this Comment On January 23, 2010, at 3:46 PM, TMFEditorsDesk wrote:

    @Owens7301,

    Thanks for the comment.

    It goes to show that arrogance and poor incentives aren't a monopoly of Wall Street.

    Do you have any other lessons from your 40+ years of investing experience that you're willing to share?

    Thanks,

    Anand (TMFBomb)

  • Report this Comment On January 24, 2010, at 8:47 PM, Chickenpookie wrote:

    These analysts earn every dime.

  • Report this Comment On January 24, 2010, at 9:34 PM, XMFTheATrain wrote:

    Good article. Amazing that Hershey is viewed by analysts as one of the 4 worst stocks in the S&P 500

  • Report this Comment On January 25, 2010, at 9:56 PM, TMFEditorsDesk wrote:

    @TheATrain,

    Yeah, I was very surprised.

    One thing to note is that different companies have different numbers of analysts providing opinions. Hershey has 5 analysts that have rated them...3 "holds" and 2 "sells".

    -Anand (TMFBomb)

  • Report this Comment On January 25, 2010, at 10:43 PM, TheVVRT wrote:

    HSY is a nice stock with a value of more than what its stock price shows but as far as buying or selling the equity I would do neither. Its potential of going up to $40 is likely but anything beyond that at this time is will probably not happen. The potential of it droping has the same chances; $34 is possible but anything below that is not likely. I would rate this as a hold for now wait and see what happens a little later.

  • Report this Comment On January 29, 2010, at 4:54 PM, TMFEditorsDesk wrote:

    @TheVVRT,

    I don't mean to imply that Hershey is necessarily a buy at today's prices...just that it doesn't warrant one of only 4 sell ratings out the entire S&P 500.

    -Anand (TMFBomb)

  • Report this Comment On January 29, 2010, at 6:40 PM, jkpamin wrote:

    Fully agree. This is because markets are not open, free, and fiscally responsible! They are carefully controlled, and manipulated. Knowingly, unknowingly, or helplessly wall street, analysts, CEOs, and even Government is taking it to slow, but sure destruction...

    If proper rules are set, integrity is maintained, and poisonous discretionary money is taken out; it will be taken care off automatically! For example, real owners of the company are its stockholders. If they don't make money, its CEO should have a bread, not lucrative whole house! On the contrary, parent would stay hungry to feed other householders!!! And, similarly the money should be passed on to its rightful owners with proper discretion, cost structure. But, I guess there is no cost accounting involved nowadays!!!

    Hopefully, right minded policy makers, and organizations like yours will unite to change this corrupt structure for good for all...

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