It Literally Pays to Ignore the Analysts

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Sep 29, 11 It Literally Pays to Ignore the Analysts

It happens too often. The herd mentality grips Wall St. as investors follow stock analysts like lemmings off a cliff. The only difference is that the analysts profit from your untimely end. For small investors it quite literally, pays to ignore them.

We’re going to show you that there’s a certain mythology around stock analysts. Their recommendations are not designed with the individual investors’ interests in mind. Instead, they are guided by each analysts’ biases and are ultimately self-serving.

On the surface, it seems like these analysts are usually right. The 10 stocks that analysts rated as a “buy” and “strong buy” a year ago delivered a 24% return. This seems good compared to the S&P 500, which gained just 13%.  

But, if you had actually bought the 10 stocks that Wall Street was most pessimistic about, those stocks gained 32%. It’s obvious that their recommendations will not make you profit more in the market; in fact it results in poorer performance.

But, why do their stock picks perform so poorly?

Very simply, analysts are human and their research is warped with conflicts of interest as well as psychological baggage. Last year, the consulting firm McKinsey looked at a quarter-century of analysts’ earnings forecasts and compared them to actual earnings. Every year, sell-side analysts were over-optimistic and slow to revise their forecasts.

This can be explained by looking in terms of the interests of these banks and funds. To buy a certain position it usually takes weeks since they must spend a large amount of money and are subject to regulations that limit the amount of stocks they can purchase at any given time. Analysts will use their clout and supposed “expertise” to manipulate investors to free up stock to purchase.

Moreover, fund managers are measured by their performance quarterly where they must hop from one hot stock to another praying for profitability so they can keep their job. Thus, they are not interested in their long-term performance as most individual investors are.

How you can play in this market? One thing is for sure, if you play with the big boys, you will get killed. Luckily, it pays to be small and stealthy.

Funds are subject to far more rules and regulations than you are. They are usually too big to buy stocks from small companies with small market caps. Others are restricted funds, which are not allowed to buy foreign stocks, and are restricted to stocks listed in the S&P 500. Thus, they will often miss good opportunities.

If you’re looking for success in the stock market, there are couple things you need to do:

  • Ignore the noise. As shown, analysts’ stock tips and recommendations are no better than a pile of bovine excrement. Take them with a grain of salt.
  • Make sure you do your research. Nothing is worse than walking blindly into a stock. Know as much as you can about the industry and the company.
  • Look at the fundamentals and valuation. Make sure that you’re not paying a ridiculous price for a poor company. Investigate its financial strength as well as if you’re getting a bargain.