Chris Umiastowski is the growth investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.
How should DIY investors treat analyst reports? If you are a do-it-yourself investor, chances are you've seen plenty of comments made by equity research analysts in written reports. Maybe your discount broker provides these reports directly to you, or maybe you read summaries of them in the news. Should you pay any attention to them? As a former analyst who wrote such reports for over a decade, I can tell you the answer is … sort of.
I think it's important to understand the intentions of "sell-side" analysts, which is the industry term for equity analysts who work for the brokerage houses. These analysts don't write their reports for the public. They write reports to serve the institutional investment community who are their clients. These institutions, such as mutual funds, pension funds and hedge funds, pay for stock analysis through trading commissions. They direct more trading dollars to firms who employ analysts they like. So, the job of a sell side analyst is to be well-liked by clients, and one way to do this is to publish reports that clients find interesting. The reports mostly serve as marketing pieces for the analyst because they initiate direct conversations with clients.
When you realize research reports are really marketing pieces, it's easy to see why several smart analysts can have wildly different opinions on the same stock. It's easier to get attention from clients if your story on a stock has a different angle. So, while analysts certainly have positive intentions and try to be right all of the time, the real motivating factor behind their work is to form a differentiated view and market that as a report with a stock target price and recommendation (usually buy, hold or sell) on the front page.
If all you do is look to a sell-side analyst's report for a target price or buy/sell recommendation, then you're missing the point, and you may as well never read another report. In the world of professional money management, most clients (called the "buy side") don't care at all about an analyst's recommendation or target price. Instead, they care about the data an analyst may have gathered, or the critical thinking that went into making a particular recommendation or earnings forecast.
In other words, professional investors already have an investment thesis on a stock they are following, and they really don't look to sell-side analysts to give them bottom-line recommendations. Instead, they gather all kinds of varying viewpoints from competing analysts and consider which ideas, opinions and data points make the most sense.
Unfortunately, the investment community is designed to focus on short-term performance, so analysts tend to present analysis to support a short-term recommendation. Will Apple's gross margin rise or fall as its manufacturing partners switch over to making the newest iPhone? Will the timing of Samsung's newest smartphone conflict with Apple's launch? These are just two examples of the short-term-relevant but long-term-irrelevant problems that analysts spend time trying to solve. In my first experience as an analyst on Bay Street in 2000, I listened to my colleague, who covered the oil and gas sector, talking about a cold snap that would drive up demand for natural gas over the next few weeks. It couldn't be more irrelevant to the long-term performance of the business, and I was shocked that anyone cared about such nonsense. But they did. And they still do.
Some of the time, you'll see analysts discuss factors that really do matter in the long term. Will the rising market share of Android combined with low-cost hardware from China put pressure on Apple's ability to charge as much as it does for iPhones? That's a long-term trend worth paying attention to, in my view. But even when analysts discuss this stuff, they tend to focus on how it will affect earnings in the next 12 months, rather than thinking about the longer term effects.
So, should you bother to read analyst reports or think about the details of these reports as written about in the financial media? Yes and no. I think you should completely throw away any target price and recommendation information, and toss out any discussion that doesn't pertain to the long-term performance of the business. Leave that to the pros who chase this kind of unimportant information. Spend your time looking at the more interesting discussions that actually matter to the long-term performance of a business.
Chris Umiastowski