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Guest Post: How To Profit From Brokerage Research
Submitted by Charles Rotblutt of AAII
How to Profit From Brokerage Research
Though brokerage analysts are frequently wrong with their recommendations and price targets, there is value in their research. The key is to know what to look for and what to ignore. Here are three key items I discuss in my book, Better Good than Lucky: How Investors Create Fortune with the Risk-Reward Ratio.
The buy or sell rating is typically the most often quoted part of a research report. The inherent problem is that brokerage analysts are infatuated with the word “buy.” According to Zacks.com, approximately half of all stocks covered by analysts currently have the equivalent of a “buy” recommendation. Conversely, just 2.5% have the equivalent of a “sell” rating. (Obviously, if so many stocks are buy candidates, wouldn’t a more cost-efficient strategy for brokerage clients be to simply invest in an index fund, such as the S&P SPDR (SPY)? Such a strategy would certainly save on transaction costs, while still providing exposure to many of those “buy” candidates.)
The simple fact is that analysts loathe putting a sell rating on a stock. This is why you should look past the rating and instead pay attention to what factors the analyst is looking at. Specifically, focus on industry statistics, specific ratios and other criteria that shed light on how the business is doing. For example, if the analyst cites a specific industry report or publication, see if it is available on the Internet. Such data will give you a good framework for doing your own analysis of business trends.
Analysts’ price targets also receive a lot of attention. The problem is that a price target is nothing more than an educated guess. Most frequently, analysts rely on discounted cash flow (DCF), a mathematical model that calculates how much a company’s total future cash flows are worth today. Like any model, DCF is only as good as its inputs and the inputs are based on many assumptions. To give you an idea of just how difficult it is to forecast cash flow, consider your own personal situation. You might have a decent idea of what your salary will be two years from now, but can you tell me how much cash will you have after spending on home repairs, car repairs, medical bills, vacations, taxes, etc.? Forecasting cash flow for a company is even harder.
Since a company is ultimately worth what it will earn in the future, DCF does have a place in valuing a company. However, since DCF is based on assumptions, a margin of error needs to be applied to the number calculated by the model. I suggest investors assume any price target based on DCF is at least 10% too high in order to provide some room for error.
Finally, there is the projection of what a company will earn in the future. Though everyone likes a positive earnings surprise, the fact that Thomson Reuters says 73% of S&P 500 companies topped third-quarter consensus estimates shows just how wrong analysts are. This said, as a group, analysts do tend to be fairly good about judging whether profits will be better or worse than originally thought. Thus, a change in the consensus earnings estimate can provide some insight. Specifically, rising estimates are a good sign and falling estimates are a bad sign. Be sure to take note of the magnitude of the change as well. A one-cent change in projected profits of $1.00 per share is not very significant; a one-cent change in projected profits of a nickel per share is.
Most importantly, treat brokerage research as just one part of your analysis, not the sole reason to buy or sell a stock. Research reports are written for mass audiences and the arguments stated in a report may or may not apply to your investing style or personal criteria.
Charles Rotblut, CFA, is a Vice President for the American Association of Individual Investors and the AAII Journal Editor. His new book is Better Good than Lucky: How Savvy Investors Create Fortune with the Risk-Reward Ratio
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99% of most research departments got it wrong on stocks which are sensitive to hiring and employment.
Korn Ferry made a huge move today. They must be headhunters for all the PigMen firms.
Suggest something afoot like Citigroup branches in China -> Korn/Ferry Intl linkage (maybe through people as Ms. Miao Cao?).
Make the right payday for somebody in research and their research will be whatever you would like it to be.
TBTF always get the *prime* research, straight from District of Criminals.
Everyone else is subject to *special* DOJ inquiries if they happen to scratch-out short term profits...
You ain't on the *A* list, you're on the *FU* list.
I must be missing something on BABs. The Federal gov't sends the issuing municipality 35% of their annual interest cost, and the municipality pays taxable rates. Or, the issuing municipality pays non-taxable rates, which are approx. 35% lower than taxable rates.
So this is what I'm missing. What's the difference?
Municipalities figured out they can keep their uber-borrowing under the local voter radar with this BAB scheme and its evil debt cousin, lease revenue bonds. If you think national voters are finance-stupid, you ain't seen nothin' til you get into some of these little yahoo towns. Wall Street and the banks are still working over these little burgs.
The interest on BAB is taxable, so that opens up the universe of potential buyers to include long-term money like pensions, endowments, and foundations. These investors avoid traditional munis because they are already tax-exempt and won't accept the lower absolute yield on a muni relative to a similar maturity corporate.
Brokerages don't do research. That's like writing an essay and pretending it is an equation.
Cfa titles are like candy anymore. They used to mean something, now it just means you're someones shill.
Buy side, sell side anal-ist depends on the paycheck and how much you can fuck things in their direction.
...and fuck brokerage research.
Profit = Precious Metals! Fuck Stock Brokers!
Hoser
There you go again assuming that John Public is still interested in buying stocks or reading a bunch of research drivel. NOT INTERESTED IN SUPPORTING CORPORATE FAGS AND CORRUPT CRONIES TO BUY MY POLITICIANS WITH MY MONEY.
A lot of 'research' for public digestion is done by interns from 3rd years to few years research. So the correct approach is to ignore it 100%.
There's not that many people that can tear apart a company, value the pieces and put it together as a package again.
people use fundamentals? i thought you just traded with the Fed or against the Fed
Learn to analyze stocks like the big boys!
http://www.bostonwealth.net/2010/03/06/stock-price-analysis/
Short their research and make trillions
I have for 30 years.
They give a buy - you sell
They give a sell you accumulate and sell back to them in 18 months.
They are idiots - you are not.
Failed brokers become researchers and analysts.
It is as it always has been. Shit floats to the bottom
Having been in the equity business for a long time, I can confidently assure you that the vast majority of analysts are as much use as a chocolate teapot. They are indeed corporate whores, pimped out by their investment banker masters to support their latest money losing scheme (if you're the investor, that is). On the rare occasions you do meet an analyst that adds value and is prepared to say 'Sell', you can be pretty sure they don't work for one of the big firms. Sell side research in general is unimaginative, reactive and scripted. The way to get value from it is to look for evidence of herding and do the opposite.
All rather simplistic and obvious, and anyway, I know a much surer way to profit from the stuff: get a job at an IB writing it.