By Dan Dzombak, The Motley Fool
Filed under: Investing
A few months ago, some Harvard Business School professors came out with a study on what factors drive analyst buy recommendations. Read on, and I’ll explain the problem with analyst recommendations, what the professors found, and how you can profit from all this.
Wall Street recommendations
Wall Street analysts have a variety of conflicts of interests and are far too positive; as such, their recommendations are known to not be that useful. Being negative is hard for analysts, as there really is no incentive for them to be negative. Negative reports don’t get people excited, don’t drive much business, and often management teams will stop speaking with analysts who are negative. Also, if an analyst makes a small error in a negative report, investor relations departments are not forgiving, whereas in a positive report, IR departments are much more forgiving of small errors.
With no incentive to write negative reports on companies, only 6% of U.S. analyst recommendations are sells. Internationally, the number is slightly higher, with an average of 9% of recommendations as sells around the world.
Top factors
Given their overly positive bent, what do you think would be analysts’ top factors?
Take a moment to think about it…
The results, which are organized by the location of the analysts, are interesting both for what analysts found very important and what they found least important.
Factors that drive buy recommendations for analysts
(A = Asia, E = Europe, L = Latin America, U = U.S.)
|
Factors / Importance |
Low |
Moderate |
High |
Very High |
|---|---|---|---|---|
|
Well-communicated strategy |
ALU |
E |
||
|
Ability to execute strategy |
AL |
U |
E |
|
|
Governance strength |
AL |
E |
U |
|
|
Quality of top management |
L |
AEU |
||
|
Innovativeness |
A |
U |
E |
L |
|
Low-price strategy |
AL |
E |
U |
|
|
Superior products or services strategy |
AEL |
U |
||
|
Balance sheet strength |
AELU |
|||
|
Culture |
AEL |
U |
||
|
High performance compensation |
AEL |
U |
||
|
Projected industry growth |
E |
ALU |
||
|
Industry competitiveness |
L |
AEU |
Source: Harvard Business Review, “What Makes Analysts Say ‘Buy.'”
Very important
Analysts called out projected industry growth and quality of top management as factors they consider to be very important. While it is good to hear that analysts find management extremely important, it is worrisome that projected industry growth is the other most important factor to them.
Studies have shown that analysts are terrible at estimating growth in both the short and long term, consistently overestimating growth. A study that looked at analyst estimates from 1984 to 2006 by Patrick Cusatis and J. Randall Woolridge of Pennsylvania State University found …read more
Source: FULL ARTICLE at DailyFinance