I gotta admit that I enjoy knocking the fickle posture of analyst ratings. One day analysts are hyping a stock, and the next day they downgrade it. Many times nothing has changed in the intervening days, weeks, even months, to necessitate the change, and oftentimes I feel they make these prognostications simply to justify their salaries. Yet sometimes they get it right.
When I first read that shares of leading aesthetic laser maker Candela (NASDAQ:CLZR) had jumped on an analyst upgrade of the stock, I had to see who said what. After all, it was right after Candela had reported first-quarter earnings that an analyst downgraded the stock, and sure enough, it was the same analyst changing his mind. Clearly this was another example of just how indecisive analysts are.
Yet when I read that the Needham & Co. analyst changed his mind based on valuation, I had to admit that I agreed with his decision. The stock had sold off more than 24% since the earnings release and it was just overdone. Candela posted 22% revenue growth and turned a $5 million profit; it had reported losses last year. In fact, I had said investors should look for buying opportunities in the mid- to upper teens, and this was just such a time for the stock.
Candela has been locked in a pitched battle with Palomar Medical Technologies (NASDAQ:PMTI), Syneron (NYSE:ELOS), Cutera (NASDAQ:CUTR), and others to gain market share for its aesthetic lasers. It's a booming industry, both here and abroad (more than 50% of Candela's revenues come from abroad), and the broader the installed base of lasers, the better it is for growth. Candela turned in respectable numbers this quarter, just not what its CEO had anticipated the previous quarter.
So maybe Candela's management didn't properly manage expectations, as I suggested, or maybe it was simply investors locking in profits. The stock had more than doubled over the last six months, and after it spent an equally long time trading sideways, some investors may have been itching to get out. So the Needham & Co. analyst was right to suggest that this stock was now reasonably priced considering the growth potential it still carries.
Of course, it raises the question of why he felt the need to downgrade Candela only two weeks before. Actually, it's not so difficult to decipher. Analysts are not long-term investors. They are looking as far ahead as the next earnings report, maybe two. A stock might look to be "getting ahead of itself," so he needs to say it is no longer a buy but is rather something to just hold or sell. When, or rather if, the stock falls, he's then able to change course and say buy.
For long-term investors, however, such short-term thinking is anathema. Instead of thinking "what is this company going to do this next quarter," we only need to consider whether the company has the wherewithal to grow for years if not decades. That's why when Candela was languishing in the single digits after some disastrous quarters of missed estimates, I did not sell my shares but rather held tight. Here was a company that had the goods to deliver some spectacular results but was seemingly facing a problem executing the plan. Still, while I didn't sell I also didn't buy, and that was my mistake because even with the pullback, I would be sitting on some tidy profits.
Yet if I followed every twist and turn of an analyst's call, I'd be riding a crazy roller coaster of both emotion and financial ruin. I'd be trading in and out of stocks, racking up transaction costs and capital gains taxes. Simply by holding onto the shares I was able to see whether Candela could really get its act together.
Analysts change their opinions about companies about as often as I change my socks. One of the tricks to generating long-term profits is to ignore the shifting winds of analyst sentiment and focus solely on the ability of the company to deliver. For while the analysts sometimes get it right, even a broken clock is correct twice a day.
You can analyze the situation with these related Foolish articles:
- Candela's Cool Beam
- Candela Brightens on Sales Growth
- Candela Burns Holes in Logic
- Candela's Lasers Offer Dim View
Fool contributor Rich Duprey owns shares of Candela but does not own any of the other stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.
