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Inside the Market This is just how bad analysts were at predicting stock moves in 2018

It was a tough year for Canadian stocks in general, and an even tougher year for Bay Street’s top picks.

Not only did those equities with the very highest analyst ratings at the start of 2018 underperform the market, they were among the segments of the market to post the worst returns on the year.

While a global downturn in commodities was responsible for many busted top stock picks, the list of analyst darlings that flopped in 2018 spans almost every sector of the Canadian stock market.

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How analyst stock picks turned out

The following chart divides S&P/TSX

Composite stocks into quintiles, based on

analysts’ recommendations for 2018, and

shows each group’s average price return

for the year.

Most

bullish

Least

bullish

0%

-2

-4

-6

-8

-10

-12

-14

Avg. S&P/TSX

return: -13.2%

-16

-18

1st

quintile

(most

bullish)

2nd

3rd

4th

5th

quintile

(least

bullish)

THE GLOBE AND MAIL, SOURCE: BLOOMBERG

How analyst stock picks turned out

The following chart divides S&P/TSX Composite

stocks into quintiles, based on analysts’

recommendations for 2018, and shows each group’s

average price return for the year.

Most

bullish

Least

bullish

0%

-2

-4

-6

-8

-10

-12

-14

Avg. S&P/TSX

return: -13.2%

-16

-18

1st

quintile

(most

bullish)

2nd

3rd

4th

5th

quintile

(least

bullish)

THE GLOBE AND MAIL, SOURCE: BLOOMBERG

How analyst stock picks turned out

The following chart divides S&P/TSX Composite stocks into quintiles, based on analysts’

recommendations for 2018, and shows each group’s average price return for the year.

Most

bullish

Least

bullish

0%

-2

-4

-6

-8

-10

-12

-14

Avg. S&P/TSX

return: -13.2%

-16

-18

1st quintile

(most bullish)

2nd

3rd

4th

5th quintile

(least bullish)

THE GLOBE AND MAIL, SOURCE: BLOOMBERG

Why might the highest-rated stocks be more vulnerable to the kind of broad market corrections seen in 2018?

One reason is a reluctance by equity research analysts to cast doubt on the market’s hottest stocks, said Brandon Osten, chief executive of Toronto-based Venator Capital Management.

“They're likely to be almost universally bullish at the top, when there's a lot of risk to the downside,” said Mr. Osten, a former sell-side analyst. “When a darling falls from grace, it's going to get absolutely crushed.”

There is no shortage of big Canadian stocks that posted big losses last year despite overwhelming analyst support.

The collapse of Canadian crude oil prices amid a shortage of pipeline space weighed heavily on nearly every energy stock in the S&P/TSX Composite Index. But going into the year, there was nothing but “buy” ratings for companies such as Torc Oil and Gas Ltd. and CES Energy Solutions Corp., which declined by 42 per cent and 52 per cent, respectively.

Other Canadian stocks with little to zero negative analyst coverage at the start of the year include Spin Master Corp., SNC-Lavalin Group Inc., Chorus Aviation Inc., Intertape Polymer Group Inc., Detour Gold Corp., Altus Group Ltd. and Boralex Inc. Each of those names fell by at least 20 per cent on the year.

As a group, the one-fifth of the S&P/TSX Composite Index with the most bullish analyst ratings fell by an average of 15.2 per cent in 2018. That’s considerably worse than the index itself, which declined by 11.6 per cent.

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The only other cross-section of the market to perform worse than the highest-rated stocks, in fact, were the lowest-rated stocks, which declined by an average of 17 per cent.

More analysts foresaw trouble ahead for companies such as Laurentian Bank, BlackBerry Ltd., WestJet Airlines Ltd. and Hudson’s Bay Co., all of which posted 2018 share price losses of at least 30 per cent.

This suggests that equity analysts are more adept in identifying stocks to avoid rather than picking winners, if 2018 is any indication.

“Sell” recommendations are certainly a relative rarity on Bay Street – of the more than 3,000 individual ratings currently on stocks in the S&P/TSX Composite Index, only about 4 per cent of them are “sells.”

For analysts that go negative on a company they cover, there could be repercussions in terms of access to management, for example.

That makes bearish commentary on companies inherently worth paying attention to, said Dennis Mitchell, CEO of Starlight Investments Capital.

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“When companies are rated a ‘sell,’ it's rare and usually courageous,” Mr. Mitchell said. But it is also typically an extrapolation of an existing trend, he added.

Mr. Mitchell cautioned against relying too heavily on “buy” and “sell” recommendations and price targets, rather than the substance of equity research reports.

“A little bit of knowledge can hurt you,” he said. Stock research can offer valuable insight into an industry or a company’s operations, which may or may not be reflected in the actual rating.

“An analyst might like a company that has been beaten up, from a valuation standpoint. But valuation by itself has never been a catalyst for companies to outperform,” Mr. Mitchell said.

Analysts have also been known to raise their outlook on a stock for no other reason than to catch up to recent performance.

“The stock moves up to their target price, they don’t want to downgrade, so they just increase their target price with absolutely no new information,” Mr. Osten said.

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Downgrades, on the other hand, tend to have good reasons behind them, Mr. Osten said.

“When analysts maintain their downgrades, that’s a pretty important sign. Because you know they’re itching to upgrade it. Management is going to be talking to them about reversing their call.”

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