Brokers Call

Brokers Call For You

Broker recommendations are in effect summaries of investment research reports that identify a stance taken by the broker in respect of the company. Broadly these can be a “buy, “sell” or “hold” or variations of these such as “overweight”, “underweight” with the report going into more depth as to the reasoning for a given recommendation. Often a “price target” is provided in each case which gives a view on where the researcher thinks the share price will move over a given period.

The stance taken in investment research is reviewed periodically, but usually at least twice a year. It is possible that the recommendation changes over the course of the year, in response to changes in company performance, or that broker “drops coverage” of the company and withdraws a recommendation. Most investment institutions are likely to update their recommendations in the light of significant changes at the company in question, specifically when corporate activity takes place, the board embark on a new strategy or otherwise provides trading updates or company results.
For the most part, broking analysts are highly-regarded in financial circles. Most have a strong knowledge of the industry they cover, often including years of direct experience, and have good contacts with the main corporate players. Their reports can therefore promote market efficiency by helping investors to value companies more accurately.

Yet many studies have identified biases in the way analysts think. In particular, they tend to favour companies with:

  • high price/earnings (P/E) ratios
  • high price/book (net assets) ratios
  • high cash flows, even if it comes from investments rather than business operations
  • growing accruals (liabilities and non-cash assets. e.g. goodwill)
  • strong past sales growth
  • a record of long-term earnings growth
  • rising trading volumes
  • positive price momentum

Apart from the last factor – positive price momentum – the evidence is that the other characteristics are associated with worse investment outcomes. Although it sounds counter-intuitive, analysts have a strong preference for stocks with features that consistently detract from long-term performance.

Why do they choose these stocks?

Working out why analysts prefer companies with less than compelling financials has attracted much attention. Some of the popular explanations are that:

  • analysts’ financial incentives are not always consistent with producing the most accurate forecasts possible
  • going out on a limb with a non-consensus forecast could damage their reputation if it ends up being wrong
  • their reports may be influenced by the broker’s investment banking relationships
  • stocks with ‘glamour’ characteristics are easier to sell than ‘turnaround’ stories
  • psychological and/or cognitive biases may play a role

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Any advice provided by Laverne is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.