Opinion: Why you can’t trust Wall Street analysts

Published: May 9, 2018 8:35 a.m. ET

As individuals, they’re experts; as a group, their motives are questionable

How many companies in the S&P 500 Index do you think have majority “sell” ratings by analysts? The answer is zero.

Here’s another statistic that may surprise you: In a typical quarterly earnings season in the U.S., two-thirds of S&P 500 SPX member companies tend to publish earnings per share that are higher than the consensus estimate among analysts, according to S&P Global Market Intelligence.

Think about that for a moment. If each analyst had good information to formulate reasonable estimates, the average “beat” rate would be expected to be 50% or so. After all, a company’s earnings per share (EPS), even if accurately predicted, can come in a penny higher or lower than the estimates. And why is that beat rate stuck at around 67%? Is it some magic number, like the golden ratio?

The folly of ‘guidance’

Many companies provide earnings “guidance,” which analysts incorporate in their estimates. For companies, guidance — in other words, the outlook — is designed to “under-promise and over-deliver,” in order to set up earnings beats, which propel the stock higher.

Analysts are much more likely to rate stocks buy than sell, and if the beats help push stock prices higher, their track records as stock pickers look better.

The conclusion: If you invest in stocks, you had better take analysts’ ratings and earnings estimates with a grain of salt.

Analysts’ biases

Analysts’ research can be help investors learn about companies, but you have to do your own research to understand if a company can make it in the long run. A broad look at sell-side analysts’ ratings shows a strong positive bias, along with outlooks that are far too short.

For generations, stock brokers have made investment recommendations to clients, often backed by their firms’ equity-research departments. Regulations are supposed to keep sell-side analyst operations separate from firms’ investment-banking operations to assure objectivity. But that doesn’t seem to be happening.

Short time horizons

Analysts base their ratings of stocks on price targets they set. The ratings are buy, sell and hold, or, alternatively, outperform, underperform and neutral, or overweight, underweight and equal weight. Nearly all analysts provide 12-month price targets.

But owning a stock for a single year is fraught with risk. Even steady performers can post losses at any given time. So why do analysts keep 12-month price targets? Good question.

Are any stocks rated ‘sell’?

Getting back to the first statistic mentioned in this article, there are no companies in the benchmark S&P 500 with majority “sell,” or equivalent, ratings among analysts.

For the S&P 500, there are actually 505 stocks because five of the companies in the index have two classes of common stocks.

Among the 505 stocks, analysts have majority buy ratings on 266.

For example, there are still 47 analysts who cover Amazon.com Inc. AMZN and 45 rate the stock “buy.”

There’s exactly one S&P 500 stock for which 50% of analysts rate the shares a sell: News Corp.’s class B shares NWS But it turns out that only two analysts cover the class B shares, while 13 analysts cover the class A shares NWSA For class A, four of the analysts rate the shares a buy, with eight neutral ratings and one sell rating.

Here are the 10 S&P 500 stocks that at least 30% of analysts rate “sell”:

You can click on the tickers for more information about each company, including price ratios, stock performance and charts, estimates and financial results.

In fairness, we should also list the S&P 500 companies analysts love the most. Here are the 11 with “buy,” or equivalent, ratings from 90% or more analysts:

Delta Air Lines DAL is the only company among the S&P 500 with 100% “buy” ratings. All 20 sell-side analysts love the stock.

Earnings games

During first-quarter earnings season through May 4, 81% of S&P 500 companies had reported results this earnings season, and 79% of them beat consensus estimates for EPS, according to S&P Global Market Intelligence. That’s higher than the typical quarterly “beat rate” of about 67%. The reason for this quarter’s elevated beat rate might be that some analysts have been conservative when updating their 2018 earnings estimates to factor in the lower maximum federal income tax rate signed into law by President Trump in December.

So don’t read too much into analysts’ ratings, earnings estimates, earnings beats or earnings misses. Still, you should certainly read analysts’ research reports on companies you invest in or are considering for investment. The analysts also publish informative reports covering entire market sectors or industries.

Philip van Doorn

Philip van Doorn covers various investment and industry topics. He has previously worked as a senior analyst at TheStreet.com. He also has experience in community banking and as a credit analyst at the Federal Home Loan Bank of New York.