Despite trying to not let emotion color our investment decisions, we still get that rush of adrenaline when an analyst upgrades our stock, or that pang of fear when it's downgraded.
Yet for all the share-price moving and shaking that this game of buy-sell-hold creates, do we really even know what the analysts are saying? Lehman Brothers (NYSE: LEH) upgraded Satyam Computer (NYSE: SAY) today with an "overweight," while Intuitive Surgical (Nasdaq: ISRG) was knocked down to "market perform" by a Wachovia (NYSE: WB) analyst. Should we be elated or upset by the respective developments?
For a long time, Fools have cautioned that getting caught up in the upgrade/downgrade charade is a loser's proposition. As my colleague Jim Mueller showed last year, there's no edge for investors to profit if they base their investing on analysts' forecast revisions. Analysts are very much a trailing indicator, rather than a leading one. They react to what's happened in a stock's rearview mirror just as much as everyone else, rather than looking out the front windshield at the road ahead.
Moreover, when analysts upgrade a stock to a "buy" or "outperform," they're not necessarily speaking the same language. In his book Full of Bull, former stock analyst Stephen T. McClellan pulls back the curtain to reveal that when Bear Stearns (NYSE: BSC) analysts say "outperform," they're not talking about the stock beating the market; they just mean that it's better than their industry coverage. A Smith Barney "buy" means the analyst expects a total return from the company in excess of 15%.
That Lehman Brothers overweight rating from before? It means that Satyam is expected to "outperform the unweighted expected total return of the industry sector over a 12-month investment horizon." Wachovia's "market perform" actually means what it sounds like; analysts believe that the stock is "appropriately valued," and that its total return -- match the market's over the next year. When Wachovia says "market perform," it means "hold."
Of course, Foolish investors have great fun with analysts who advocate sellingyour shares (or rate them an "underperform," as Wachovia does), only to turn around later and upgrade the same company to a "hold." That's what a Deutsche Securities (NYSE: DB) analyst did today with Western Refining (NYSE: WNR). How are you supposed to hold your shares if you've already sold them?
By and large, analysts are very smart people who often have a firm grasp of a company's position and potential performance within an industry. Paying attention to what they say about the business is often a useful exercise that can help you understand your own company's strategy. Still, like a cold call from a stock broker at dinnertime, you're better off hanging up on their three-card Monte shell game of buy-sell-hold.
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