How Much do you Trust Stock Market Analysts?

Bloomberg recently ran an article about Meredith Whitney failing to keep up with her past success in forecasting.

Meredith Whitney is a banking analyst who was propelled to fame by correctly predicting Citigroup’s inc. dividend cut. Her recommendation to sell bank stocks propelled her to the forefront during the financial crisis. In 2007, Forbes magazine listed Whitney as the second best stock picker in the capital markets industry. In 2008 her bearish views on banks landed her on the cover of Fortune magazine.  She moved on to found her own firm in 2009.

It seems that Meredith has lost her touch since two-thirds of her picks (13 out of 19 recommendations) have fared worse than market indexes so far this year. This is not the first time nor will it be the last time a Wall Street star will rise and fade into the darkness.

Of course Whitney, just like any other analyst, can just brush all of this data off by claiming that her picks are a long term hold but so can everybody else!

The Art of Clairvoyance

Forecasting the future direction of a stock is what stock analysts are paid for. They will dig up a company’s past and extrapolate several variables into a future price prediction. These variables take into account everything from management skill to past earnings and anything in between before issuing a recommendation.

Assuming that the analyst is competent, no matter how many certificates he holds or how big his salary is he is not always better placed than you or me in most cases because he is exposed to the following risks:

Random Events: How about a black swan event? Unforeseen events have appeared and will reappear in several forms such as regulatory, environmental, terrorism or an international incident between 2 countries.

Kitchen Cockroaches: Do you remember Enron? Quarterly financial reports reveal important information about the company but they can also be manipulated to hide crucial information. If you discover a cockroach in your kitchen, chances are he has buddies you haven’t met.

Conflict of Interest: How do we know the analyst is not spinning a positive research report to benefit his investment banking division? (Underwriting new issues, advising firms on borrowing, restructuring or acquisitions…).

Final Thoughts

Even though Analysts like Whitney might be able to move the market with their opinion they will never be able to come out with a perfect streak. Just like you and me, they submit to the random walk theory of the markets. Anyone can throw predictions around and over a certain period of time he is bound to hit one of them just like a broken clock can be right twice a day!

To be fair, competent analysts are potentially better positioned than us thanks to their in depth knowledge of certain sectors. On the other hand, they should never be raised to the pedestal of prophets when it comes to their forecasting because of this edge.

Personally, I take the time to read research reports and review price targets on the stocks that interest me. However, ultimately, I take the final decision when it comes to pulling the trigger based on my own conclusions.

How much trust do you put into a stock picker’s recommendations? Do you buy “blindly” because you are “piggy backing” on his research?