Don’t be shy, ask ii…are broker ratings worth following?

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Andrew Horn asks:What has puzzled me for too long is 'Broker Ratings'. What is the timescale for these very precise price targets to be achieved? At what date was the previous target expected to be reached?

Often it appears that (inaccurate) forecasts are altered to reflect more closely the present position, to 'hide the broker's tracks'. 

Grateful for answers, please, because broker ratings [examples supplied] seem to have little worth.

Lee Wild (pictured above), Head of Equity Strategy, interactive investor, says: Thanks very much for your question, Andrew, this is a subject that interests many investors who are keen to know if the views of highly paid analysts are worth following.

For the answer, we must first understand who these analysts are, what they do and why they do it. 

Most are smart cookies working either for investment banks or brokers. Their research helps the bank’s traders decide on strategy and is also made available to clients at a cost. Every company listed on the stock market will also have a house broker whose job, among other things, is to publish research on the company.

Analysts build close relationships with the companies they cover, speaking to senior management about strategy and finances. Like accountants, they are adept at crunching numbers using clever formulae and software. They will typically generate forecasts, including for revenue, profit and dividends, for at least each of the next two or three years. Research notes set out the ‘house view’ (the bank or broker’s opinion) of a stock, which includes how its conclusions were reached, whether they believe the shares are a ‘buy’, ‘hold’ or ‘sell’ (or something in between) and a price target. 

• You can find the latest broker ratings here between 9am and 10am each day
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Ratings and price targets typically reflect a 12-month view, although it does depend on the target audience. Research for an institution tends to take a much shorter-term view, since many want trading ideas. Retail investors, on the other hand, might be more inclined to invest for the long term.

Targets are often the result of computerised number crunching, which explains why they can be very precise. However, analysts do not have a crystal ball, and these are just opinions based on a range of assumptions. So, while they believe the share price should hit their target area at some point in the next year – or the shares should at least be worth that if valued fairly by the market - they can’t possibly predict exactly when that will be. 

It is also likely that market conditions will not remain consistent for 12 months. Influential economist John Maynard Keynes is reported to have said, “When the facts change, I change my mind”. So do analysts. This explains why they upgrade or downgrade their view on stocks, and why price targets can change. Even small tweaks can have a significant effect on forecasts and, therefore, price targets.

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Because analysts use many assumptions, ratings can differ from one to the next. Forecasts, and the many influences on the company and industry within which it operates, might be interpreted differently. Of course, it is impossible to always get it right. However, over time, individual analysts, teams of analysts or investment houses can establish a strong track record and reputation for accuracy. These are the ones investors like to follow.

Analysts are often criticised for issuing far more positive research notes than negative ones, allegedly to win business from the companies they write about. Investors also joke that if 10 out of 10 analysts rate ABC Plc shares a ‘buy’, it’s time to sell. But rather than follow ratings and price targets religiously, the best approach for an investor is to use the analysis – typically upgrades or downgrades to ratings and price targets - as a measure of sentiment. Many hours of hard work go into compiling the research, which is usually packed with facts about companies and industries that you would otherwise never know.

So, despite some shortcomings, many investors do find broker ratings a valuable tool for decision-making, but with all the usual caveats, and usually as part of a broader piece of research or due diligence. You can find out more tips on how to do your homework on stocks here.