Most individual investors rely on ratings from Wall Street research analysts when investing their hard earned money. But the big question is: are these analysts as reliable as retailer investors expect them to be? A study conducted by NerdWallet gives an entirely different picture. Let me tell you one thing, most of the time you are far better off investing in low cost mutual funds, rather than investing in individual stocks recommended by an analyst.
NerdWallet investigated all the 883 analyst ratings issued on the Dow Jones 30 stocks in 2012. All the recommendations were latest issued prior to 1st January 2012. Then it compared the recommendations to stock performance through 2012. NerdWallet found that only 51 percent of the recommendations were correct. Yes, predicting stock movement is challenging, but you do expect highly paid analysts with decades of experience to at least beat the average. And 49 percent of analysts failed on that parameter.
To give you a more clear image, it is slightly better than taking a blind guess as to where the stock is headed over the next year.
Accuracy of Ratings
If you break the rating into buy, sell and hold, you’ll notice a significant bias in favor of buy ratings. The study found that about 70 percent of buy ratings were correct, which accounted for 85 percent of all the accurate recommendations. Just 20 percent of all the hold ratings were correct (meaning their returns were within 2% of the market index). NerdWallet researchers found it difficult to judge the performance of sell recommendations because there were only 38 sell ratings out of 883.
It indicates that analysts can pick winning stocks more successfully, but their predictive power is useless when it comes to hold and sell ratings. NerdWallet said that analysts who don’t understand a stock or are unable to forecast, may put a Buy rating on the stock. So, even if you want to rely on analysts, you can trust their buy ratings to a certain extent, but not hold and sell ratings.