A Superior Strategy for Remarkable Gains

If you're investing even a small chunk of money, you've probably noticed the various action records of analysts who've made calls on companies. Buy, Sell, Hold, Neutral, Overweight, Underperform, etc. -- the list is extensive and exhausting. Even if I could find one or two firms whose research staff I trusted, I don't think I could keep up with their constantly fluctuating stances on companies. The process is really not for me.

The best of the Street
So I was intrigued to stumble upon a recent article in The Wall Street Journal that rated the best analysts from the best firms in 2006. After looking at some of their top picks, I wasn't surprised to see some real winners. Three of the top 10 analyst picks included:

Clearly, each firm and its clients had great success with these stocks. However, I was more concerned with the experience that the average investor might have had with that particular stock over the past year. In the chart above, I included the number of downgrades on the stock during 2006, because I suspect that investors attach a lot of weight to what these big-league analysts have to say.

Mixed messages
That number tells me that, throughout 2006, as these stocks made their bullish moves, they faced significant negative sentiment from investment firms. Granted, the majority of the downgrades came from other firms with separate research departments, but even Stanford Group downgraded Akamai in September 2006, only to see the stock run up another 17% before the close of the year. The same goes with Morgan Keegan, which downgraded EMC in August, only to see it lunge forward another 36%. Had you been persuaded by either downgrade, you would have lost out on additional gains.

With all these mixed signals flying about, it's no wonder the everyday stock picker is left questioning whom to trust -- and when. Consider the case of Accredited Home Lenders (NASDAQ:LEND). Both Roth Capital and Bear Sterns upgraded Accredited to "Buy" and "Outperform" in late 2006. Some investors might have used this sentiment to purchase, or perhaps double down on, an existing investment. These same people saw the stock lose more than half of its value in March alone. Thankfully for investors, both firms chimed in with a downgrade toward the end of Accredited's decline. (Sarcasm intended.)

Totally missing the mark
I don't want to harp on other people's mistakes for too long -- I've certainly blown calls. But check out some of the tremendous gains that firms may have scared investors away from, just in the past few months. These companies were all downgraded right before amazing surges in prices:

A better way to do it
There are three things to take away from all the buy/sell/hold/overweight noise.

First, do not sell a stock simply because an investment house -- even one you've come to trust -- downgrades it. Use a downgrade as a reason to do more research on a company. Perhaps something has changed, perhaps not. Either way, a blind sale can burn you. Firms like HSBC are complex institutions moved by all sorts of different factors that may or may not fall within your unique set of circumstances. Hopefully, the table above shows that this happens quite regularly.

Second, do not try to play the upgrade, downgrade, buy-and-sell game. You will lose. Many an investment firm makes money by constantly shifting in and out of stocks, but many more eat their returns alive by practicing the fruitless game. The individual investor will suffer even worse with commission costs and taxes -- and headaches. Do not attempt to replicate this kind of strategy. That's something legendary investors like Peter Lynch and Warren Buffet will back up.

Third, find a great company and stick with it. When you see firms upgrading and downgrading a company several times over the course of a year, they may be simply chasing yesterday's news.

Stick to your guns
If you've purchased a stock and you remain confident in its prospects, hold fast. Forget what the analysts have to say. This strategy, more than anything, will lead to returns that are robust and stress-free.

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Fool analyst Nick Kapur owns no shares of any company mentioned. Buffalo Wild Wings and Ctrip are Hidden Gems recommendations. MasterCard is an Inside Value recommendation. Akamai and aQuantive are Rule Breakers recommendations. The Fool has a disclosure policy.