Like it or Not, Analysts’ Ratings Still Matter

One of the factors I like to take into account when analyzing a stock is the analysts’ ratings. It is just one measure of sentiment that can be tracked and quantified, and then I combine the sentiment indicators with the fundamental analysis and the technical analysis to come up with what I consider to be the total picture of a stock’s current situations.

I bring this up at this time because I include the analyst ratings in the articles I write for Seeking Alpha. Recently I have had readers respond to a couple of articles with, “who cares what analysts think?” While I can certainly understand why readers would ask that question, there is still value in analysts’ ratings, but probably not in the way that you are thinking.

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I use the analysts’ ratings in a contrarian manner. No, I don’t think I am smarter than the analysts and just make trades that run counter to them. Instead, I look at the total number of “buy” ratings, “hold” ratings, and “sell” ratings and take this in to account. For instance, if XYZ company has 25 analysts following it and 24 of the analysts rank the stock as a “buy” and only one ranks it as a “hold”, there is a much greater chance of a downgrade than there is an upgrade. And even though we might not care what the analysts think, a downgrade can cause a stock to fall.

For example, on January 8, 2020, Palo Alto Networks (NYSE: PANW) received a downgrade from Bank of America and the stock fell 1.27% on the day. For those of you not familiar with Palo Alto Networks, it is a software company that products help secure a company’s network. According to Investor’s Business Daily’s industry ratings, Palo Alto Networks is the fourth ranked stock in the Computer Software- Security industry. The stocks that rank ahead of it are Fortinet (Nasdaq: FTNT), NICE Limited (Nasdaq: NICE), and Cyber-Ark Software (Nasdaq: CYBR).

While Palo Alto fell on January 8, most stocks gained ground. Palo Alto’s peers all saw significant gains that day with Cyber-Ark gaining 3.66%, NICE moved up 2.47%, and Fortinet tacked on 1.59%. Why did Palo Alto fall while its peer rose? Because of the downgrade of course.

Sure it is only one day, but if you have numerous downgrades over the course of a few weeks or a month, it can lead to the stock underperforming its sector. Hopefully, this isn’t the case for Palo Alto since it is one of the stocks in my model portfolio.

Like I said earlier, I don’t make investment decisions based solely on the analyst ratings, but it is one part of the equation. As another example, I was working on an article yesterday about the upcoming earnings of the large banks. Bank of America (NYSE: BAC), Citigroup (NYSE: C), and JPMorgan Chase (NYSE: JPM) will all announce earnings next week. I went through and looked at the fundamentals of all three, I looked at the charts for all three, and then I looked at the sentiment for all three. In my opinion, JPMorgan Chase has better fundamentals than the other two. All three of the charts look similar, but the sentiment is far less bullish for JPMorgan. One aspect of that sentiment is the analysts’ ratings.

The Wall Street Journal classifies ratings in five categories: buy, overweight, hold, underweight, and sell. To make it easier for my purposes, I consider buy and overweight as “buy” ratings, and underweight and sell as “sell” ratings. With that in mind, here is what I found for the three banks.

We see that analysts are far more bullish on Citigroup than they are JPMorgan, even though JPMorgan has seen earnings and sales grow faster. JPMorgan’s Return on Equity is higher and so is the profit margin.

When I see a company that has performed better than its peers fundamentally and yet it has more bearish sentiment toward it—that is a perfect scenario for me. Then it is just a matter of waiting for the right time to buy the stock.

Am I suggesting that you should rush out and buy JPMorgan today? Of course not. All three of these bank stocks are overbought right now and we may see all of them fall or consolidate for a few months. However, if the fundamentals remain as they are, I will be watching JPMorgan over the coming months and I will look to buy it rather than Citigroup or Bank of America.

About Rick Pendergraft

Rick has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick’s analysis process includes fundamental, sentiment and technical analysis. Rick started college as an education major, wanting to teach economics, but eventually changed to majoring in Economics and received a Bachelor of Science in Economics from Wright State University. His desire to inform and educate people is at the heart of his writing.

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