Whether you realize it or not, Wall Street analysts can actually be wrong. However, if you watch financial programs on TV that interview Wall Street bigwigs, or follow the price action in stocks shortly after a rating or price-target change from a Wall Street firm, you're likely to believe otherwise.
Surprise! Wall Street can be wrong
From the perspective of the individual investor, a Wall Street firm and its covering analysts might appear to be all-knowing. It's their job to focus all their efforts on understanding the dynamics of an industry or sector, as well as analyze the underlying businesses within that sector or industry. Unfortunately, even the best investors tend to be wrong between 30% and 40% of the time -- meaning even Wall Street analysts are fallible.
For instance, microcap Synta Pharmaceuticals imploded in October after announcing that its lead drug, ganetespib, an Hsp90 inhibitor, was being discontinued in its phase 3 GALAXY-2 trial. An independent data-monitoring committee determined that it was unlikely to meet its primary endpoint of a statistically significant improvement in overall survival over the placebo in a lung cancer study.
Drug failures aren't all that uncommon, but as recently as August, Wall Street firms had price targets ranging from a low of $6.50 to as high as $15 per share on Synta. As of this writing, shares of Synta were trading below $0.45 per share.
Being wrong isn't limited to just small biotech stocks. 3D printing giant 3D Systems (NYSE:DDD) not long ago boasted triple-digit price targets. Canaccord Genuity's two covering analysts, Bobby Burleson and Prabhakar Gowrisankaran, noted in April of last year that 3D Systems' new products should have little trouble selling, and the company at the time expected $1.42 in EPS for the upcoming year (2015). This was Canaccord's reasoning behind its $100 price target. However, shares of 3D Systems closed yesterday below $9 as capital spending for 3D Systems' core customers has slowed, and the consensus estimate for its full-year 2015 profit has dipped to just $0.16.
Long story short, Wall Street can be wrong. These are just two examples, but there are plenty of others out there; and you don't have to look too hard to find them.
Why you shouldn't blindly follow Wall Street
There's more to it than just Wall Street being wrong from time to time. Wall Street analysts also have little to no accountability for their calls. If a Wall Street company forecasts that a stock could head higher, and instead it loses half of its value, essentially nothing happens to the company or the covering analyst. Investors, on the other hand, could be saddled with huge losses for having blindly followed the suggestion of a Wall Street company.
Another major problem with blindly following Wall Street is that its analysis is often based on past performance. Investors are typically forward-looking in their analysis of a company, and deciphering whether a price target established by a Wall Street company is for the short term or long term can give the individual investor a headache.
Finally, Wall Street firms have a very line-in-the-sand approach to their analyses of companies or industries. Wall Street firms tend to take a hardline buy, hold, or sell stance on a company, and an opinion that's different than the official firm's position on a stock typically isn't allowed, or is at least strongly discouraged. In a way, you could say that buy-side analyses ignore potential risks, while sell-side calls ignore the potential catalysts that could lead to a rebound.
Take charge of your own research
Just because Wall Street firms are fallible like you and I doesn't mean we need to ignore them completely. Wall Street's long-term analysis of a company's business model or outlook can provide important starting points for research for an individual investor. But the key point is that the onus of success or failure rests solely on your shoulders as an individual investor.
Taking charge of your own investment portfolio can provide a number of advantages as opposed to simply following Wall Street's stock ratings. For starters, you'll likely eliminate the stress of trying to time the market. As noted above, some Wall Street analysis focuses on the long term, but there are quite a few calls that are reactive, rather than proactive, to a bad quarterly report.
If you have done your homework and believe in the long-term business model of a company, then a few bad quarters is unlikely to shake you out of your position. Remove trying to time the market from the equation -- something Wall Street analysts try to do far too often -- and you'll almost assuredly experience less stress from your investment portfolio. Plus, you'll ensure that you don't miss out on the market's biggest up days.
Secondly, we have far more flexibility as individual investors than Wall Street does. Wall Street firms are often constrained by market valuations -- they typically don't cover small-cap stocks -- or are confined by investing within a region, such as the United States. As an investor who's taken charge of your own research, you're free to invest in stocks of all sizes, and there are no confining borders as to where you can invest.
Finally, if you handle your own investment research, you'll be better prepared to evaluate investment opportunities in other aspects of your life. Understanding what to look for in, and how to value, a stock or mutual fund could give you invaluable insight in terms of valuing a home, for example, when searching for a house to buy.
Stop relying on Wall Street, and consider making the move to become a self-sufficient investor today.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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