“Is there a recommendation to buy stocks in the company?”
“What do the analysts say about it?”
These are the kinds of questions I often hear people ask when they are considering investing in a company.
Most people have blind faith in stock analysts as experts and prefer to check their assessment of a company before doing anything on their own. They have the same faith in the analysts as they have in physicians when dealing with their children’s health.
But stock analysts are not experts in the same way as lawyers or pediatricians.
A stock analyst’s work is linked to a commercial purpose in the bank.
My advice to you is to avoid reading stock analyses from the big financial houses because there are some built-in flaws in the system that make it hard to trust them.
You should instead train your do-it-yourself muscle in conducting your own research and making decisions before you buy shares.
One way you can learn how is by using my 1-page checklist here.
Let’s get to the point. What’s the problem with stock analysts’ recommendations?
There are five…
1. The Bank Makes Money From Fees and Commissions
The analysts are employed by the banks. The banks, of course, make money from the fees you pay every time you buy or sell shares. Or, if you use a stockbroker, from the commission they get.
That means that there is a financial interest in getting you to trade more actively than you would otherwise do. You could say that the research and the recommendations work as appetizers to make you become more active in the market.
The recommendations work like stoplights in traffic – green, yellow… or as they call it, buy, hold, sell – so you feel that you need to keep an eye out and be active.
The analysts and traders in the banks live like fish in symbiosis in a small aquarium. The stockbrokers will try to whet your appetite for a trade by sending you their colleagues’ stock analyses.
2. The Analysts Are Dependent on the Companies They Cover
The companies decide who they want to invite to dinners, meetings, and to special events like their capital market days, which are occasionally held in luxurious surroundings.
I attended a capital market day at a Four Seasons in California for one of the Danish hearing aid companies. The hotel room, the dinner and the party that took place were so extravagant that I still talk about it today.
The companies can choose to cut an analyst off from all that if they don’t like the analysis.
If an analyst is cut off from the company’s communications and invitations, it’s difficult to cover that company in the future.
This makes it almost impossible to make harsh sell-recommendations or any analyses that really expose the company’s weaknesses.
Therefore, the banks’ analysts tend to make more buy than sell recommendations.
3. The Analysts Move Like a Hoard
You often see that recommendations are similar to each other. There will be a dominant trend and a bit of a domino effect where they rub off on each other.
This is because it’s difficult to go against the pack.
If you get it wrong, you are very exposed if you were the only one who held that point of view. You can get fired for that.
If the whole pack is wrong, it’s easier to hide and shrug it off.
4. An Analyst Covers One Industry
An analyst is specialized. They usually only cover one sector or industry, and that makes it hard for them to have a bird’s eye view on matters.
For example, an analyst might cover pharmaceuticals or the financial sector. The one covering pharmaceuticals will know very little about banks, and vice versa.
This means that an analyst’s recommendation is based on a very narrow perspective.
The analyst does not have an overall view of whether it is a good time at all to invest in bank shares – or whether there are better opportunities in another corner of the market.
5. Analysts Only Cover the Largest Companies
There is a whole undercurrent of companies that are completely ignored by both analysts and the media.
The bank must be able to generate enough revenue from the trade that it makes sense to have an analyst employed to cover the company.
This means that many wonderful companies are ignored and overlooked simply because they are not among the biggest on the stock market.
So What Should You Do?
You have to master the ability to do your own research. You do this by knowing what to look for.
In my e-book Free Yourself, I teach you the process I use to review a company before I invest.
You can learn to do the same.
Begin with the e-book, and if you want more information, you can join a free webinar, and later on, my intensive value investor course.
Keep an eye on the e-mails to get notified about future webinars and courses.
Download my e-book Free Yourself here. When you do that, you have the option to get emails from me about future opportunities.