Equity analysts and what you should know

Independent Investor spoiled child — the analyst needs to see benefits from their work or they can have a tantrum.

The best example is ‘Sell Netflix — Buy Blockbuster’ (Google it for the full story) where a stock analyst — for 12 years — insisted that Blockbuster was going to defeat this new company called Netflix. But there are dozens of other examples, where an analyst “falls in love” with a stock and refuses to believe it has turned for the worse. Or insisting (like on the Bre-X fraud) that “the gold is there, I’ve seen it.” Like individual investors, and people in general, analysts have a really hard time admitting they are wrong. Keep this in mind the next time you read a glowing report on a “not so great” company. ahead of the analysts’ upgrades.

We had to laugh a week ago at the analyst calls on NVIDIA (NVDA on NASDAQ). Both BMO and Nomura downgraded the stock, and Nvidia shares dropped by $10 apiece. The BMO analyst put an $85 target on the shares, now $102. But a quick history search will show BMO had just a $15 target on the stock less than three years ago, and in early February the stock hit $120. So, while the BMO analyst has more or less been completely wrong on the stock for years, they still managed to help send the stock down sharply on a downgrade. Does this make much sense? We don’t think so.

Don’t get us wrong. Most analysts are very bright, hard working individuals. But in addition to the above points, they insist on using target prices, which require forecasting of not only a company’s fortunes but also market valuations, interest rates, world events, sector trends and investor sentiment. Trying to get all of these right is a fool’s game. Analysts are also handcuffed by not wanting to offend companies (which is why there are so few SELL ratings) and by having to predict 90-day trends at companies, with such focus on quarterly earnings. All of this makes their forecasting ability suspect, and it might be better for the average investor to ignore them.

When we were a fund manager, we did talk to analysts. The basic information they provide on companies is solid. One of our favourite tricks was to get analysts talking about companies they did not officially cover, because that’s when the analyst could really let their guard down and tell us what was really happening, without any conflicts or other restrictions.