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Why following analyst ‘buy’ ratings will leave you poorer

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Some investors dismiss broker ratings out of hand, preferring to trust their own stock picking abilities.

Broker in the pack

Others assume that brokers are intelligent, well-paid professionals who have carefully researched the stock in question and are worth paying attention to. However, new research from online platform AJ Bell suggests a third and highly cynical view might be the right one. Instead of trusting brokers or ignoring them, you should pay close attention to what they are recommending, and do the exact opposite.

Last year was a rotten one for brokers. AJ Bell’s research reveals that the FTSE 100 stocks that attracted the highest percentage of analyst ‘buy’ ratings in January 2017 markedly underperformed the index and actually delivered a negative return.

Sell the buys

Shire Pharmaceuticals started the year with a massive 25 buy recommendations from 29 brokers. Only one recommended selling, yet Shire’s share price subsequently fell 16.7% over the year. The second most tipped FTSE 100 stock, Dixons Carphone, named a buy by 12 out of 14 brokers, did even worse falling a whopping 43.9%.

Brokers redeemed themselves with Tui IG in third place and Smurfit Kappa at four, both of which grew around 33%. But hotly tipped Babcock International fell 26%, Hikma Pharmaceutical fell 40%, while Provident Financial, tipped by a conclusive eight of 10 brokers, crashing a whopping 68.6%.

Think about it. Eight of 10 brokers preferred Provident Financial. Neil Woodford, you are not alone.

And buy the sells

As if that wasn’t damning enough, the 10 companies with the highest percentage of ‘sell’ ratings a year ago all beat the FTSE 100 index as a whole. Incredibly, they even did better than the 10 most popular stocks.

Just two out of 19 brokers recommended buying Rolls-Royce Holdings, which went on to grow 28.5%. Just two out of 25 favoured Royal Bank of Scotland, which leapt 23.8%, and mining giant Antofagasta, up 48.9%. They were right to be sceptical about INTU, Marks & Spencer and Standard Chartered, though. So they aren’t all bad. Even so…

Nobody knows

Russ Mould, investment director at AJ Bell, was damning in his verdict. “Ultimately, what the data does seem to show is the well-informed, diligent, expert broking community has little more idea of what is coming than anyone else, at least in the short term.”

One option is to simply buy the entire index through a tracker. Anyone prepared to pick their own stocks must thoroughly research any company for themselves first. This clearly isn’t easy – just ask those brokers – but Mould suggested following the lead of Charlie Munger, Warren Buffett’s vice-chairman at Berkshire Hathaway, who boils it down to four things:

1. Do you understand the business?

2. Does the business have intrinsic value or durable competitive value?

3. Does management have integrity?

4. Does the stock come at a reasonable valuation?

Another lesson is that if you like an investment, don’t be put off simply because you are out of step with consensus. As Warren Buffett  once said: “You can’t buy what is popular and do well.”

Brokers are living proof of that maxim.

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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has recommended Hikma Pharmaceuticals, Shire, and Standard Chartered. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.