It's Time to Stop Listening to Wall Street Analysts

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Few people on the planet know more about a given company than a sell-side Wall Street analyst. They can recite growth rates, measure market opportunities, and probably tell you the name of the CEO's youngest grandson. Despite of all of these things, you are probably a better long-term investor.

A few weeks ago, First Niagara (NASDAQ: FNFG  ) , a regional bank in the Northeast, reported earnings and informed investors of the bank's plans to accelerate investments needed to boost revenue and improve the long-run fundamentals of the business. Sounds like a good plan, right? Wall Street didn't think so, and the stock dropped more than 10%.

Because the plan forgoes the "consideration of near-term profitability," analysts at Deutsche Bank found the move "perplexing" and lowered their price target, because looking out three to four years is "beyond many investors' time horizons."

In some sense, the analysts were doing their job and catering to their hedge fund clients, who apparently see three years as just too darn long. This move isn't too surprising. A survey of analysts found only 35% considered "the profitability of [their] stock recommendations" to be very important. The evidence backs this up as well. 2013 was a spectacularly bad year for the "brains" on Wall Street as the stocks with the most sell ratings crushed the market.

If you're still not convinced most Wall Street analysts aren't exactly Warren Buffett 2.0s, consider the fact that on January 23, a Citigroup analyst downgraded Lamar, the outdoor advertiser, from buy to neutral. Just two weeks later, the same analyst upgraded Lamar back up to buy and raised his price target. The reason? He expected lower cash interest expense and divulged that "since then, we've received feedback from clients on 3 fronts..."

It wouldn't be farfetched to think a few big hedge fund clients weren't too pleased with the recent downgrade and made a few phone calls. So much for analysts being objective.

Most of you reading this do not have an active relationship with a team of Wall Street sell-side analysts, so why even listen to their recommendations? They are serving a client base with a completely different mind-set and situation than you. These analysts don't know you, how much time you have until retirement, your current salary, your debt situation, or how many kids you need to send to college.

When's the last time you saw a Wall Street recommendation that said this:

We are downgrading Company XYZ from neutral to sell because Jim is 55 years old with two daughters entering college, and we believe selling to pay for their education is a better idea than taking out a second mortgage on his suburban home.

Trick question. That's never been written.

The idea isn't to be completely cynical about Wall Street analysts, but to be aware of their incentives, client base, and expertise -- which is not recommending stocks to hold for decades. The key to building wealth over time isn't about predicting next quarter's earnings per share or jumping when others say "jump," but the ability to focus on your individual situation and think about investing in terms of decades instead of tomorrow's headlines. 

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Comments from our Foolish Readers

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  • Report this Comment On February 21, 2014, at 2:58 PM, WineHouse wrote:

    I've become convinced (emotionally, not "rationally") that most analysts serve up their opinions for the benefit of specific large (e.g., hedge fund or institutional) "clients" -- not to inform the clients, but to CREATE A MARKET CONDITION that would induce ordinary folks to either buy up (i.e., bid up the price of) or sell off (i.e., bid down the price of) that particular stock. And what do you think the large clients might then do after such an analysis is published? It's called market manipulation, and IMHO it happens a lot.

    BTW, analyst publications are not the only way to manipulate a market. If the company has a small enough "effective float," the share price can be manipulated by a large investor by selling a whole bunch at once to depress the market price, then buying up more than they sold but just a little bit at a time while it's still low, with the goal of accumulating net shares at the low low price. A similar thing can be done to pump up the price (buy a whole bunch at once, then sell off as much as possible -- just a little bit at a time -- while the price is artificially high. It only works for companies with small floats, but it could help explain a lot of the volatility and weird price swings we sometimes see. And "effective float" doesn't necessarily reflect company size; for example, if a large proportion of shares are held in index funds, those fund managers are not in a position to respond to such market swings.

    Not that I'm cynical, of course ...

  • Report this Comment On February 21, 2014, at 7:22 PM, whyaduck1128 wrote:

    What irritates me the most about these analysts is how upset they get about companies' missing the ANALYSTS' target numbers, as if meeting those numbers is more important than doing the best job possible and making the most money, hopefully in a legal, ethical manner. If the company meets the earnings number, the analysts get upset over the revenue number--or the gross profit number--or...something.

    It's as if they live to get upset about the very companies they follow.

    I look for the analysts who don't change their minds unless overwhelmed by the evidence, not the ones who reverse course every time they forecast earnings of $1.15 and the company announces $1.13 or $1.18.

  • Report this Comment On February 24, 2014, at 10:23 AM, TMFJCar wrote:

    Great article David!

  • Report this Comment On February 24, 2014, at 11:07 AM, Mathman6577 wrote:

    Lately Apple seems to be on the wrong side of many of the so-called analysts in spite of generally good data (wake up -- Apple isn't going to have 60% EPS growth anymore). For example, selling a record 51 million iPhones (instead of the "estimated" 55 million) was a "disappointment".

    One "analyst" said he went to the Apple store on 5th Ave. in NYC on the day the iPhone 5s and 5c first went on sale and he noticed that the crowds were smaller than for the iPhone 5 release the previous year. He predicted lower sales numbers than previous estimates. When Apple announced that a record 9 million devices were sold on the first 3 days he said "he fell out of his chair".

  • Report this Comment On February 24, 2014, at 11:25 AM, ffbj wrote:

    If an analyst thinks a stock I like is bad I think they are wrong. If they think a stock I like is good, then I think they are right.

    Too many analysts, to me, like Cramer says: is a danger sign. I think.

  • Report this Comment On February 24, 2014, at 12:14 PM, jlh939 wrote:

    Totally agree with WineHouse. What is worse is when the media falls in line with those manipulations. Why do most outlets report changes in the DJIA as points instead of a percentage? At three hundred points down news anchors start reporting like Chicken Little screaming that the sky is falling, instead of a more sensible lede. If they said the Dow is down 2 percent instead, I would respect them more.

  • Report this Comment On February 24, 2014, at 12:32 PM, TheCommonTulip wrote:

    On average, Wall Street analysts are wrong about half the time. IMHO the reason is that they are under intense pressure to be right; this of course leads them to the dangerous tendency of telling you what just happened. They anchor their outlook toward a stocks recent track record, rather than where it's going.

    Apple for instance was, at one point last year, downgraded by an analyst at Citi four weeks after it was upgraded. Could the business have changed that dramatically in four weeks? Likely, no, it was a response to the stocks drop (at that time).

    Great article.


  • Report this Comment On February 24, 2014, at 1:42 PM, Mathman6577 wrote:

    Predicting the short term movement of a stock is like providing 10-day weather forecasts. Meteorolgists and stock analysts must have gone to the same colleges.

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David Hanson

David has been with The Motley Fool since 2013. He is a graduate of the University of Miami. Follow David on Twitter for all things finance, marketing, and investing.

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