At The Motley Fool we warn investors about reading too much into Wall Street downgrades. News of a downgrade can send shivers through the market, but often it's best to ignore analyst chatter.
Why, you ask? Because Wall Street analysts get it wrong more often than not.
Let me repeat: Analysts get it wrong. I hear this statement so often from Fool writers that I've been taking it as a given. But are analysts really that far off? I mean, it's their job to understand the companies they follow.
I decided to investigate and see if I could put some real data behind this assumption.
The numbers don't lie
Take a look at this history of analyst opinions for Intel (NASDAQ:INTC) from CSFB. I've determined CSFB's bullish ratings (Outperform, Buy, and Strong Buy) were a success if the stock beat the market between the time of the rating and the next upgrade or downgrade. Bearish ratings (Sell and Underperform) were successful if the stock underperformed the market in that time, and the Neutral rating was successful if the stock performed within 5% of the market return.
Only two out of eight ratings were accurate. Seems silly to worry about analyst opinions now, doesn't it?
CSFB Opinions for Intel:
|
Rating |
Date |
Return |
Return vs. S&P 500 |
Success? |
|---|---|---|---|---|
|
Neutral |
9/16/2005 |
5.28% |
1.10% |
Yes |
|
Underperform |
11/23/2004 |
6.16% |
0.98% |
No |
|
Outperform |
9/30/2003 |
-15.08% |
-33.25% |
No |
|
Buy |
1/16/2002 |
-18.36% |
-6.69% |
No |
|
Hold |
2/13/2001 |
3.92% |
18.42% |
No |
|
Buy |
10/18/2000 |
-15.06% |
-13.32% |
No |
|
Strong Buy |
1/11/2000 |
-14.84% |
-8.14% |
No |
|
Buy |
4/14/1999 |
57.35% |
49.06% |
Yes |
Merrill's report card
Okay, so maybe CSFB got it a wrong a few times. Other analysts might have done better. Let's check in on the venerable Merrill Lynch.
Merrill Lynch Opinions for Intel:
|
Rating |
Date |
Return |
Return vs. S&P 500 |
Success? |
|---|---|---|---|---|
|
Neutral |
7/12/2004 |
0.00% |
-16.19% |
No |
|
Buy |
7/14/2003 |
9.24% |
-1.76% |
No |
|
Neutral |
2/20/2003 |
41.13% |
21.21% |
No |
|
Sell |
11/15/2002 |
-9.47% |
-1.47% |
Yes |
|
NT Neutral |
6/6/2002 |
-30.37% |
-18.78% |
No |
|
NT Strong Buy |
1/31/2002 |
-22.95% |
-14.00% |
No |
|
NT Accumulate |
10/17/2001 |
42.61% |
37.68% |
Yes |
|
NT Neutral |
4/23/2001 |
-18.96% |
-6.94% |
No |
|
LT Accumulate |
10/18/2000 |
-20.60% |
-11.83% |
No |
|
NT Buy |
7/6/1999 |
19.57% |
22.88% |
Yes |
|
NT Accumulate/LT Buy |
3/18/1999 |
4.87% |
-0.56% |
No |
Merrill Lynch's ratings are a little more confusing because it gives Near-Term (NT) and Long-Term (LT) ratings. But we can decipher which ratings are meant to be bullish (Accumulate and Buy) and which are meant to be bearish (Sell).
Over a roughly seven-year period, Merrill Lynch analysts made the correct call three out of 11 times. That's a 27% success rate! If you had made buy and sell decisions for Intel based on analyst recommendations, your performance would have been dismal.
This is a small sampling of analyst opinions, but it should give you some idea of what to expect the next time your stock is downgraded.
What went wrong?
So why do analysts have such a low success rate? First and foremost, Wall Street has a very short-term outlook. I don't care how good an analyst is -- predicting price movements over a one-year period is difficult. If you truly feel a stock is a good value, it may take three years or more for the market to come to the same conclusion.
Second, analysts may have conflicting interests that could influence their opinions. Analysts may inflate their ratings in the hope of driving lucrative investment banking business to their firms. In 2002 Merrill Lynch and other firms were fined by the Securities and Exchange Commission (SEC) for this very practice.
Foolish bottom line
The next time your favorite stock falls on a downgrade, view it as a potential buying opportunity. Has the fundamental business changed in any material way? If not, you may be able to pick up the stock on the cheap (after doing some careful due diligence, of course).
Companies recently in Wall Street's doghouse include Abercrombie & Fitch (NYSE:ANF), Ann Taylor Stores (NYSE:ANN), Yahoo! (NASDAQ:YHOO), Visteon (NYSE:VC), SanDisk (NASDAQ:SNDK), and Caribou Coffee (NASDAQ:CBOU). Each of these companies had a moderate dip in share price after the downgrade.
It takes courage to be bullish on a stock when everyone else is running the other way, but the rewards can be worth the risk. Studies have shown that value investing -- identifying undervalued businesses and holding them until they reach their intrinsic value -- outperforms growth investing over the long term.
Philip Durell and the team at Motley Fool Inside Value have made it their mission to find great businesses trading at bargain prices -- often using Wall Street opinions as contrary indicators. And Philip's recommendations have consistently beaten the market. Click here for free trial to the Inside Value newsletter, and get access to all of Philip's 36 stock picks.
Take those Wall Street downgrades with a grain of salt and stay on the lookout for value. Your portfolio will thank you.
Joseph Khattab is a Motley Fool research analyst. He does not own shares in any of the companies mentioned. The Motley Fool has a disclosure policy.
