Guide to Understanding Analyst Ratings
Ratings, Price Targets, and More
Many investors have a limited amount of time to research and understand companies in their portfolio. That’s why many investors rely on professional analysts to help them make decisions about when to buy, hold, or sell. While analysts shouldn’t be the sole source of information, they provide valuable context for more detailed analysts and insights into breaking news and events that may impact price or valuation.
Analysts and Ratings 101
Analysts are investment professionals that usually hold finance degrees from universities and/or professional certifications like the Chartered Financial Analyst (CFA) designation. While their education is generalized, they often develop an expertise in a particular industry or asset class throughout their careers. For example, some analysts may specialize in semiconductor stocks and others may specialize in emerging market equities.
Analysts can be divided into two categories:
- Sell Side Analysts: These analysts are associated with the entities that facilitate the decision-making process of the buy side entities. These entities may include investment banks, commercial banks, stock brokers, or market makers. Their job is to pitch and sell assets or opportunities to others and their reports are often made public.
- Buy Side Analysts: These analysts are associated with the entities that are involved in making the investments. These entities may include hedge funds, asset managers, institutional investors, and retail investors. Their job is to help firms with capital find assets or opportunities to purchase and their reports are often kept private.
Sell side analysts have a well-known bullish bias. In general, analyst ratings in the S&P 500 tend to be about 50 percent Buy ratings, 45 percent Sell ratings, and just 5 percent Hold ratings. It’s also commonplace for companies to miss or beat analyst expectations by 10 percent to 20 percent in a given quarter, which suggests that the models used by analysts aren’t always accurate.
The verdict on Buy side analysts is still out, but it’s unlikely that they’re much better.
There are many different terms used by analysts and it’s important to understand the differences. For example, the term Buy might mean two different things depending on the analyst using the term. A Buy from one analyst might be the highest possible rating, while a Buy from another analyst might be the second highest rating after Strong Buy. Other analysts may use terms like Recommended List in lieu of the term Buy altogether.
FINRA provides a nice table that summarizes some of these differences:
Analysts also issue price targets to provide an estimate of where the price will be in a specified period of time. Often times, price targets look 12 months out from the date that they are issued and they may be updated over time.
These ratings and price targets are often included in regular research reports and shorter updates or notes. Research reports provide a broad overview of a company along with recent developments, while updates and notes are more focused on explaining how recent news or events might impact a stock.
For example, a research note might explain how new regulatory changes might impact a company over the short- or long-term.
Interpreting Analyst Ratings
Many experts recommend using analyst ratings as a starting point for further due diligence rather than a singular source for making a decision. For example, research reports might help an investor quickly determine what a company does, recent events, and roughly see how earnings are expected to grow over time. Further due diligence may involve tweaking the analysts’ projections to be more in-line with what you might expect.
There are several things to keep in mind when reading analyst reports:
- Read It All. Analyst reports tend to be very lengthy, which means you may be tempted to jump ahead to the rating and price target. But the reports often contain important information that can put these high-level recommendations into context. You should also be sure that you’re reading the latest research.
- Consider Other Sources. Analysts may distill information from a 10-Q SEC filing or other regulatory documents into a short summary, but in some cases, it’s helpful to take a look at the source material yourself. For example, you may want to read an SEC filing’s footnotes or read the transcript of a conference call to glean more insight than a short analyst summary of the event would provide.
- Consider Any Conflicts. There are no firm requirements to be an analyst, which means that some may have conflicts of interest. In general, those registered with FINRA-member firms or those holding a CFA designation are held to higher standards, but it’s important to consider if the analyst owns any stock, their relationship to the company, and any compensation that has been provided.
By keeping these tips in mind, you can be sure that you’re effectively using analyst ratings in your due diligence process and not overly relying on them to make decisions.