It's often said that emotion makes investors their own worst enemies. It causes them to buy high, sell low, or grow attached to losing stocks for the wrong reasons. Even professional analysts often follow that trend, by issuing buy ratings after big rallies and sell ratings after big declines.
That herd-like mentality makes human analysts seem unreliable, and it has opened up a new market for artificial intelligence-powered solutions. Robo-advisors, for example, can feed a client's financial background and goals through an algorithm to offer advice or automatically invest their assets.
Some financial institutions are even testing out bot analysts that issue buy or sell ratings on individual stocks. One such bot, Wells Fargo's (NYSE: WFC) AIERA (artificially intelligent equity research analyst), recently surprised Wall Street by issuing sell ratings on two market darlings -- Facebook (NASDAQ:FB) and Google parent Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL). Should investors care what this robo-analyst believes?
How does AIERA work?
Wells Fargo analyst Ken Sena led a group that worked with Bryan Healey, a former Amazon.com data scientist, to create AIERA. The bot currently tracks 13 stocks, and formulates daily, weekly, and overall forecasts for their growth.
Wells Fargo hasn't said much about the data AIERA crunches, but it's likely a combination of fundamental, technical, and news-driven trends. Sena has emphasized that the bot is intended to enhance, not replace, the jobs of human analysts, and that it remains in a test-and-learn mode that has "no current bearing" on the brokerage's actual ratings on.
What do the human analysts think?
Wells Fargo's human analysts have assigned "outperform" ratings to Facebook and Alphabet, with respective price targets of $215 and $1,250 -- more than 20% higher than their current prices.
Among the 44 analysts tracking Facebook, there are 37 buy ratings, three overweight ratings, three hold ratings, and one sell rating. The lone sell rating comes from Pivotal Research, which claimed that the European Commission's ruling against Google Shopping and its ongoing crackdown on U.S. tech companies posed a threat to Facebook's expansion. The bears also often claim that Facebook's valuation is a bit frothy at 39 times earnings.
Forty-three analysts track Alphabet, 34 of whom rate the stock as a buy, four rate it overweight, and five think that it's a hold. Analysts who issued a hold rating, like Canaccord Genuity, mostly believe that the stock's valuation is too high at 37 times earnings.
Facebook and Alphabet have also been hit by investigations regarding their sale of ads to Russian operatives during last year's election. If those investigations drag on, they could adversely impact both companies' ad revenue growth.
In a note to clients reported by Bloomberg, Sena wrote earlier this month that "AIERA’s approach this week appears decidedly more conservative (than last week), as she places a 'hold' recommendation on 11 names and even going so far as to place Google and Facebook in the 'sell' category."
Taking a more balanced look
Facebook and Alphabet both face near-term speed bumps, but the world's biggest social network and search engine don't face much long-term competition. Facebook's monthly active users rose 17% annually to 2.01 billion last quarter. Google processes about 2 trillion searches annually, reaches over 2 billion users with Android, and streams videos to another billion users on YouTube.
Based on those facts, we can conclude that Facebook's and Alphabet's ecosystems will get bigger as they conquer adjacent markets and invest in next-gen technologies like virtual reality, augmented reality, artificial intelligence, home automation, and driverless cars.
AI-powered analysts like AIERA might not factor in the growth potential of those markets, which limits their view to shorter-term trends. They also can't factor in the mainstream appeal of stocks like Facebook and Alphabet, which younger or inexperienced investors might buy as a brand with little regard for their actual fundamentals.
Bot and human analysts might think Facebook and Alphabet look pricey, but neither stock is that expensive. Analysts expect Facebook's earnings to rise 26% this year and 22% next year, which justifies its forward P/E of 26. Alphabet's earnings could dip 11% this year on higher investments, but rebound 31% next year, according to estimates. It trades at just 24 times forward earnings.
The key takeaways
Bot analysts might spot unusual spikes in trading volume, scan headlines, read earnings reports, and crunch that data against a company's fundamentals faster than their human counterparts. But many moves in the market, like the appeal of certain cult stocks, often defy technical and fundamental explanations.
I also doubt that bots can fully understand why human investors are willing to pay a premium for companies like Facebook and Alphabet. Therefore, the rise of the robots on Wall Street is interesting, but I doubt that AI analysts will completely replace human ones anytime soon.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun owns shares of AMZN. The Motley Fool owns shares of and recommends GOOG, GOOGL, AMZN, and FB. The Motley Fool has a disclosure policy.