Wall Street Is Still Cheating You

Stimulus, schmimulus. Wall Street can't be fixed the way it is, President Obama. The system needs a total overhaul.

It's not just the bankers who are to blame. Sure, hundreds of them should be in jail -- they cost us billions by taking on more leverage than they could afford and by betting on sure losers like credit default swaps on U.S. government bonds.

It was hubristic. Moronic. And directly linked to the economic conditions that argue for hundreds of billions in stimulus. Thanks for that, guys. Thanks a lot.

But here's the thing: Even if we jail the bankers, we're left with the analysts. Harvard-trained number crunchers who treat stocks as if they were part of some sort of flavor-of-the-month club. They'll cheat you out of a fortune if you let them.

How to give away a fortune
You see, analysts abide by a specific vernacular that begins and ends in 12-month price targets. That's by design; big brokers serve big clients and big clients -- institutional investors such as mutual and hedge fund managers -- move money into and out of stocks as fast as a hyperactive 2-year-old on a sugar high. These traders need to know the flavor of the month, the day, the hour, the minute.

Some even profit from the process. Ken Heebner of the CGM Focus (CGMFX) fund swaps out the contents of his entire portfolio at least three times annually yet he's produced a full decade of 16.3% average annual returns, crushing the S&P.

So why not trade like Heebner does? Two reasons:

1. There's only one Ken Heebner.
2. You aren't him.

Actually, there's also a third reason. Heebner almost never gets his ideas from the Street. "I'm not waiting for Morgan Stanley to tell me there's something wrong in China," Heebner told Fortune in a May 2008 interview. "By then it's too late."

Don't downgrade your returns
Heebner, in other words, is proof that following the Street's upgrades and downgrades isn't necessary.

But it's more than not necessary. It'll cost you a fortune. Green Mountain Coffee Roasters (Nasdaq: GMCR), one of the market's 10 best stocks of the past decade, has been downgraded to something less than "buy" six times over the course of that decade.

The first downgrade, by Adams Harkness on Oct. 25, 2002, was from "buy" to "market perform." But of course it didn't just track the market -- Green Mountain was built to outperform. Between that recommendation and now, the stock has been an eight-bagger -- versus a loss for the S&P 500.

But let's not pick on a single analyst. Or cherry-pick dates, for that matter. There's no reason to. The bottom line is this: The data shows that upgrades and downgrades don't matter nearly as much as the headlines suggest.

Every one of these winners was downgraded to something less than "buy" at least once during its five-year run:

Sources: Capital IQ, Yahoo! Finance.

Following the Street's gyrations might have earned you profits in these stocks, but it might just have cost you fantastic returns. With the S&P down more than 25% over the same period, you'd almost certainly have done better buying after the first downgrade and holding for as long as the underlying business supported your thesis for investing.

Stimulate your portfolio instead
If this process sounds familiar, it should. Fool co-founder David Gardner sustained a decade of 20% returns in the real-money Rule Breaker portfolio by zigging when the Street and major financial press screamed zag. His contrarian investing style echoes Heebner, who told Fortune that he's most comfortable as an investor "when everyone else thinks I'm nuts."

The beauty of this style of investing is that you'll rarely be short of ideas; upgrades and downgrades occur daily. Briefing.com found 20 downgrades on Thursday alone, including Deere & Co. (NYSE: DE) and ExxonMobil (NYSE: XOM). This doesn't mean you should blindly do the opposite of what analysts tell you. But when the Street screams, "sell," that's an opportunity to investigate. You may find a hidden gem waiting to be polished.

My favorite idea right now is a current Motley Fool Rule Breakers pick that, last month, was downgraded three times. Crazy. Not only is this business the undisputed leader in an emerging sector of the health-care market, but the stock has doubled since David first picked it for the April 2005 issue. Yet analysts say now is the time to sell -- just as this well-heeled cash gusher is trading within 25% of its 52-week low. Color me thrilled.

Intrigued? Click here to try Rule Breakers free for 30 days. You'll get the name of that stock, as well as our team's five top growth stocks for new money now.

Fool.com contributor and Rule Breakers analyst Tim Beyers didn't own shares in any of the companies mentioned in this article at the time of publication. GameStop is a Motley Fool Stock Advisor selection. Vertex is a Rule Breakers recommendation. CGM Focus is a Champion Funds pick. The Motley Fool's disclosure policy caught a rival disclosure policy cheating at cards last year. That policy hasn't been heard from since.