Over the years, here on The Value Perspective, we have rarely strayed from the view that analysts’ ‘buy’ and ‘sell’ recommendations add little to the sum of human existence. It therefore seemed only fair to flag up a report that suggests the opposite – even if, in our view, you will only share that conclusion if you are generous in heart and mind. And perhaps stand on one leg. And squint a bit.
As its title suggests, Impact of analyst recommendations on stock returns: Evidence from the German stockmarket sets out “to examine the impact of analysts' recommendation downgrades, upgrades and reiterations on German stock returns” and then to address the million-dollar question – “whether profitable investment strategies could potentially be designed around these recommendations”.
Having considered some 13,000 recommendations from almost 1,500 analysts on stocks listed on Germany’s main Dax 30 index, the paper’s authors suggest there is some evidence that investors can outperform the wider market by buying the ‘buys’ and selling the ‘sells’ – the snag being you must somehow manage to do this some weeks before analysts actually make their recommendations.
Now, frankly, if we had access to a time machine here on The Value Perspective, we flatter ourselves we could come up with better trading strategies than just following what analysts suggest. But still, let’s investigate the findings a little more closely and consider the following chart, which shows the average performance of stocks from 21 trading days before a recommendation to 126 days afterwards.
Source: Europa Universitat Viadrina, September 2014
One of the more striking aspects of this chart is that the stocks making up the ‘Sell’ line have already suffered a period of significantly negative performance before the analysts actually get around to suggesting investors sell. At the same time, the stocks making up the ‘Buy’ line have enjoyed a lesser but still noticeable uptick before the analysts start suggesting investors buy in.
Nevertheless, if you were to have made your buying and selling decisions based on analysts’ calls over the period in question, the spread between the two lines is 170 basis points on the recommendation day and 200 basis points on the final day of the study – implying an uplift in annualised return of around 30 basis points by buying the ‘buys’ and selling the ‘sells’, rather than just holding the ‘holds’.
That said, to judge by the performance of the ‘Hold’ line, you may just want to consider buying the ‘holds’. One thing is for sure, whether or not you have access to a time machine, if an analyst calls you one morning to say they have just made a recommendation, arguably the best thing you can do is thank them politely, hang up and then ignore them.
Even this study, which is a good deal kinder to analysts than we are ever inclined to be, suggests their ‘buy’ recommendations barely outperform their ‘sells’. More often than not, by the time these sorts of calls are made, most of the good or bad news that drives a company’s short-term share price has already taken place and, crucially, been acted upon by the market.