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Why Investors Can't Make Money Following the Analysts

Can you make money following stock analysts’ advice? The answer depends on who you are. For those with the big bucks such as hedge funds, mutual funds, and other big players, the answer is yes. But it’s a different story for individual investors. Here’s why.

If you had enough cash, you could have made serious money over the past year if you picked the right advisory firm, and then bought all of that firm’s “buy” rated stocks, and simultaneously “sold short” its “sell” rated stocks (short sellers make money when the stock they’ve shorted drops in price, but they lose if it goes up instead). 

Investars Light (www.investars.com) compiles the buy/sell ratings issued by stockbrokers and other advisory firms, and computes the returns investors would have achieved by following the “buy/sell short” strategy based on each advisor’s ratings.

Big Guys Could Make Big Money
For example, over the past year (January 15, 2007 – January 4, 2008), investors heeding the advice issued by FutureAlpha.com (www.futurealpha.com) would have netted $17.75 per day for each $10,000 invested. While $17.75 doesn’t sound like much, multiply that by the 252 stock market days in a year, and you’re talking about a 44% annual return.

Although FutureAlpha.com caters to institutional investors, second-ranked Zacks Investment Research (www.zacks.com) is open to all investors willing to pay the subscription fees. If you had enough cash to do all of the required trades, you would have averaged a $14.16 daily gain over the past year for each $10,000 invested by following Zack’s ratings. That equates to a 36% annual return.

Investars also tracks buy/sell strategy returns for the past two, three, and four-year periods. For reasons unknown, the longer-period returns aren’t as impressive as for the past year. For example, over the past two years, FutureAlpha.com and Zacks Research were still number one and two, but with smaller numbers, $9.25 per day for FutureAlpha.com and $9.19 for Zacks.

What About US?
If you’re not a big investor, it has probably occurred to you that you could use Investar’s data to find out which advisor’s buy/sell ratings are worth following for individual stocks. Even you if don’t have access to the research reports, news reports describing various analyst stock upgrades and downgrades are widely available.

The good news is that Investars does tabulate each advisor’s percentage of right or wrong calls over the one-, two-, three- and four-year timeframes. It lists the percentages separately for the “buy” and “sell” ratings. For instance, for “buy” ratings, Investars tabulates the percentage of stocks that went up from the “buy” date until a ratings downgrade, or the firm discontinued coverage of the stock. 

Discouraging Results
Unfortunately, those numbers are discouraging. For last year’s top five advisors, “buy” rated stocks only went up 49% of the time, on average. That means that if you bought based on one of these top advisor’s “buy” rating, you had roughly a 50/50 chance of making money if you sold when they downgraded or discontinued coverage.” The analysts did slightly better when advising selling. On average, 62% of “sell” rated stocks dropped.

Looking at the past four years, 59% of the top five rated advisor’s “buy” rated stocks went up, while 54% of their “sell” rated stocks dropped.

Probably, the weak market explains last year’s “sell” ratings better accuracy. After all, if more stocks are going down than up, the odds favor the “sell” ratings.

Investars tracks the results of most, but not all advisors issuing buy/sell ratings. The figures that I related were for all stocks rated by firms covering more than 500 stocks. You can run the same figures for smaller firms. Also, you can tabulate an advisor’s results compared to a relevant index, such as the S&P 500, instead of on the absolute basis that I related here.

Plenty of Ways to Slice & Dice
There’s even more. Instead of all stocks, you can limit your analysis to specific industries or to stocks in the S&P 500 or Russell 2000 indexes. Also, you can enter a ticker symbol and see which advisory firms were the most accurate on that particular stock.

To see the data, select Research Performance on Investars Light homepage. From there, select ‘By Stock’ or ‘By Sector’ if you want to limit your search based on those criteria. Use the “Rank Firms According to” dropdown menu to select “Return of Positive Ratings + Return of Negative Ratings” to display the buy/sell short strategy’s daily returns. Hover your mouse over an advisor’s positive (buy) or negative (sell) return figure to see the buy/sell ratings accuracy percentages.

Don't Wait
Everything on Investars Light is free. According to an Investars’ spokesperson, programmers are busy working on site revisions that will be implemented in a couple of weeks. The revised site will be easier to use, but it will only list the top five advisory firms in terms of buy/sell short returns on some of the reports.

So, if you want to check your favorite advisor’s results, do it soon because you may not be able to see it after the changes are implemented.
published 1/20/08

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