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Are analysts always right? Should savvy investors take their recommendations as dogma, or should they search for top stocks among their hold and sell recommendations?

Analysts do have an edge over the rest of us in making short-term earnings estimates…and not much else. They are closer to firm management than the rest of us, but their recommendations should not be followed religiously when constructing a long-term income portfolio.

The following stocks are analyst "hold" recommendations which pay dividend yields that exceed 5%. They were also screened for dividend sustainability by restricting the search to stocks with payout ratios at or below 50%. Their details follow:

 

 

Ticker

Company

Industry

Div Yield

Payout Ratio

AT

Atlantic Power

Electric Utilities

7.9%

18.8%

BKEP

Blueknight Energy Partners

Oil & Gas Pipelines

6.9%

40.0%

CLF

Cliffs Natural Resources

Steel & Iron

5.8%

14.6%

LXK

Lexmark International

Computer Based Systems

5.0%

24.1%

PSE

Pioneer Southwest Energy

Oil & Gas Exploration

8.3%

43.9%

RNDY

Roundy's

Grocery Stores

12.8%

19.0%

Are analysts justified in their "hold" recommendations? We can score each stock by risk class by utilizing their Altman Z-scores* and also check whether they are attractive bargains or richly valued by considering static valuation metrics:

 

 

Ticker

Altman Z-score

Score

P/E

P/S

P/B

P/FCF

EPS Growth Next 5 Yrs.

AT

5.50

Safe

5.52

0.59

2.13

N/A

-8.4%

BKEP

2.02

Grey Zone

10.67

1.29

2.4

38.79

2.8%

CLF

1.71

Distressed

4.32

0.92

0.98

36.69

7.0%

LXK

2.82

Grey Zone

7.5

0.42

1.17

11.86

-9.4%

PSE

7.68

Safe

5.27

4.16

3.34

N/A

5.7%

RNDY

2.56

Grey Zone

7.65

0.08

1.09

8.91

10.0%

Quantitative risk scoring vindicates analyst "hold" recommendations for BKEP, CLF, LXK, and RNDY. Only AT and PSE score as safe, which does not explain analyst ambivalence to PSE and AT. Instead, the "hold" for AT probably comes from declining earnings estimates (negative earnings growth projections) forecasted by analysts. Such ratings and projections are self-consistent, though analyst projections are not perfect and the low valuations of AT more than compensate for analyst perceived declines in earnings.

The aggregate "hold" rating for PSE makes no sense in light of the firm's positive growth forecasts, low (0.42) beta, solid Altman Z-score, and commitment to return capital to shareholders via dividend payments. In fact, both AT and PSE are promising buy picks as dividend stocks which are trading at attractive valuations.

This sample of dividend stocks demonstrates that analyst recommendations do not always segregate stocks appropriately. Income investors should follow valuation metrics to make sure they are not overpaying for stocks while simultaneously screening based on the sustainability of a firm's dividends. Analyst recommendations clearly do not capture these metrics: sometimes a "hold" should be a "buy."

Disclaimer: This article was written to provide investor information and education, and should not be construed as a guarantee or investment advice. I have no idea what your individual risk, time-horizon, and tax circumstances are: please seek the personal advice of a financial planner. This article uses third-party data and may contain approximations and errors. Please check estimates and data for yourself before investing. Moreover, this research does NOT constitute a guarantee.

*The Altman Z-Score is a measure of bankruptcy risk that is not based on stock price volatility. This score places companies into three groups: "safe" (Z-score > 2.99), "grey" (Z-score between 2.99 and 1.81), and "distressed" (Z-score < 1.81), and is surprisingly useful for identifying bankruptcy risk in the coming year. This method of segmenting companies uses of fundamental (financial statement) data and market capitalization only, not on price volatility. Beyond credit risk prediction, companies with higher Z-scores have historically outperformed companies with lower Z-scores, in aggregate. One sector has not been accurately modeled: Altman's Z-score has not accurately predicted the bankruptcy risk of financial companies.

"Distressed" was a label coined by researchers, and should not be taken to mean that any company is bankrupt or in default on the basis of this calculation alone. Credit scoring is not fate, only prediction based on relative past performance of companies grouped by key variables. Time will tell.

Source: 2 Analyst Hold Recommendations Worth A Closer Look