Look beyond ‘buy’ rating

If you learn that a Wall Street analyst has slapped a “buy” rating on a stock, don’t immediately call your broker. Ratings from analysts are much less meaningful than you might think.

Consider that as of a few months ago, out of more than 11,000 ratings on the (500 or so) stocks in the S&P 500 index from many different analysts, only 6% were “sell” ratings. More than half — nearly 54% — were “buy” ratings. If you’re starting to suspect that analysts tend to be overly rosy in their ratings, you’re right.

One reason is conflict of interest. Wall Street analysts often work for investment banks, which have many corporate clients and want to sign up even more. Clients and potential clients will prefer banks that have given them positive ratings.

Professor Ohad Kadan of Washington University in St. Louis has offered another reason: “Analysts tend to herd. There’s no big penalty if you’re wrong, because everyone else is wrong. You’ve got cover. You’re not going to lose your job. If you take a different opinion, either you get a big prize if you’re right, or you lose your job. An analyst needs to be really courageous to say something different from most other analysts.”

Fortunately, all is not lost — analyst ratings can still be helpful. That’s because they’re often accompanied by research reports, which offer far more insight than a oneor two-word rating. Many brokerages these days allow access to analyst reports for many stocks; look into what your brokerage provides, then read the reports on any companies of interest. There might still be some bias in them, but they should also contain useful data and opinions. Don’t be surprised to see conflicting opinions — there’s rarely 100% consensus about any stock.

When investing in individual stocks, gather a lot of information and do your own thinking and deciding. Or take the easy (and also profitable) route and simply invest in a low-fee broad-market index fund, such as one based on the S&P 500.