How do you pick what stocks you invest in? Do you look at a companyâs price chart? Do you try to predict peopleâs future needs (for example, investing in hearing aid companies because you think weâre all going to get hearing damage from our loud music)? There are many ways people make investment decisions, and even professional investors often rely on gut instinct for their choices. But there is one tool that most experienced investors rely on: analyst ratings.Theyâre not hard to understand, but they do contain more information than you think. An experienced investor knows how to judge analyst ratings, and more importantly, when to ignore them. Letâs teach you to do the same.
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When analysts examine a stock, they take in all the public data the company releases, plus any information they can glean from talking to the executives in earnings calls (basically, like a press conference after quarterly earnings, but for analysts). They make some guesses on those comments â if an executive says theyâre expecting âmoderateâ growth in the next quarter, an experienced analyst might know that usually means between 2% and 4% for that specific company â and put it all into a model. At the end, they come out with an estimate for where the stock price should be. Thatâs the price target, a very important part of analyst ratings. From there they decide whether the stock will perform better, worse, or in line with the broader market. If they think itâll do better, they give it a buy rating. If worse, theyâll give it a sell rating. If itâs about the same, it gets a hold rating. This is their recommendation to the investors that read their research: buy the stocks with buy ratings, sell the stocks with sell ratings. If a stock has a hold rating, theyâre recommending you should hang on to what you have, but not buy any more, nor sell what youâre holding.Letâs take a look at an actual rating in the Vivid app, for Zoom Video Communications. This is just as an example â the information here is likely outdated by the time you read it.
What youâre seeing here is an amalgamation of a bunch of analyst ratings. Rather than take the recommendation of one analyst, we collect recommendations from many and average them out. This is very common in the financial industry â the idea is that one analyst can be wrong, but itâs far less likely for all of them to be wrong.
The bars show you what percentage of analysts recommended what action. In Zoomâs case, exactly half of the analysts had a hold rating, while 46% had a buy or strong buy rating (some analysts have strong buy ratings for stocks they think are particularly promising, but this isnât a universal thing.)
At the bottom, you can see the average price target, and the current price. For Zoom, most analysts think the shares are worth 426 â much higher than the 327 they were worth at that moment. So does that mean the price is going to reach 426? Not quite.
This may come as a surprise, but financial analysts make wrong predictions all the time. There are tools that track individual analysts and their predictions, and calculate what kind of a return you would have gotten had you followed their advice. The results tend to be all across the board, even for analysts with decades of experience. Though some may have spectacular results, others may fail wildly.
Thatâs one of the reasons investors prefer to look at averages â itâs less likely that all analysts will be wrong about a stock than a single analyst will. But that doesnât mean itâs impossible.
Another thing to keep in mind â analysts tend to base their price targets on current information. That is to say, they canât see the future. The world can change fast, and stock prices change even faster. Just before the coronavirus pandemic, no analyst was really factoring in a global health catastrophe into their models. A company like Zoom wasnât even on their radar. Itâs only after the pandemic hit that they began adjusting their models.Still, if you havenât followed a company closely, an average of analyst reports can be like someone doing most of the homework for you: you can trust that theyâve seen the numbers, know how the company is doing, and have a reasonable guess of where itâs going. Whether you believe theyâre going to be proven right is, as always, up to you.
Any opinions, news, research, analyses, or other information contained on this website are provided as general market commentary, and do not constitute investment advice, recommendations nor should be perceived as (independent) investment research. The author or authors are employed by Vivid and may be privately invested in one or several securities mentioned in an article. Vivid Invest GmbH offers as a tied agent of CM-Equity AG the brokerage of transactions on the purchase and sale of financial instruments with the exception of those in the area of foreign exchange brokered by Vivid Money GmbH.