Take Analyst Opinions With A Grain Of Salt

Includes: AMZN, BAC, NFLX
by: Gregory Stuckey

I appreciate the time and effort some analysts put into researching the stocks that they follow. I get a lot of information from reading their opinions, and gather a lot of data from the research they complete. On many occasions I completely ignore their ratings, though, and encourage you to delve through the data and develop your own investment opinions -- even if they are completely contrary to the analysts following the stock. I am not a contrarian, but on many occasions I have agreed with their stock picks. Making investment decisions based on analyst opinions can, however, clearly be a mistake.

In the following paragraphs I will review the stocks I either invested in or thought about investing in where the analyst opinions were wrong when compared with the actual stock performance. I use Fidelity for my brokerage account and that is where I complete the bulk of my research when picking stocks. The analyst opinions are categorized on the website using a scale that goes from 0 to 10. 10 to 9 is very bullish, 8.9 to 7 is bullish, 6.9 to 3 is neutral, 2.9 to 1 is bearish, and 0.9 to 0 is very bearish. I believe this rating is a compilation rating based on all the opinions of the analysts who follow the particular stock.

My first example of analysts getting the stock call wrong is Amazon (NASDAQ:AMZN). The stock had a bearish rating for almost all of 2012, with it breaking into neutral territory from June to August. During 2012 the stock appreciated from approximately $170 to $250, or a gain of 47%. Certainly, the analysts were worried about the margins for Amazon and felt the stock did not warrant the high P/E ratio it carried for the year. These are all understandable items to have concerns about, and excellent points to make when doing research for stocks to invest in. However, the rating was wrong when compared to the actual stock price performance.

I did invest in Netflix (NASDAQ:NFLX) when it hit $112 around February 2012. The analyst ratings were 1.2, or very bearish at the time. The rating may have been warranted since the stock tanked all the way down to $55 a share -- talk about a gut check. I persevered, however, sure that the stock had an excellent product and excellent growth potential. This was tough since there are always a dozen articles on why you should cut your losses and sell a stock as soon as you purchase it -- or at least it felt like that to me. As you know, the share price for NFLX is currently around $185. So it has tripled over the year, but is up 50% or so for me. It never came out of bearish territory at all over the year, and still sits at 1.1 bearish in analyst sentiment. Again the analysts make excellent points about competition and cost escalation for content, but when compared to actual stock price performance I would have missed 50% gains in a year if I had blindly agreed with their ratings.

Bank of America (NYSE:BAC) is another winner over the past year that had wild swings in analyst opinions. I purchased this stock around February and it had an analyst opinion rating of about a 1.8 bearish. It fell some more before it started its positive run, but the analyst opinions shifted wildly. In February, the opinion was around 2, ran up to almost too bullish ratings (7) and then back down to a bearish (1) rating by June. As it stands today, the stock is sitting at about $12, doubling over the past year. Again, 100% gains seem to be better than a neutral rating.

But what does this mean for investors trying to make investment decisions? You should read analyst opinions and research. They are getting paid to follow certain stocks and have some very in-depth information about the stock and the products they carry. Where they are flawed is when they start expressing opinions. "Why" is the big question -- why are they wrong when they do such detailed research? I believe they may have already made up their minds about a stock, so they find the information that fits their predetermined opinion.

Or maybe they are so caught up on the details of the company that they miss the big picture, that they can't see the forest for the trees. Bank of America is a good example. They were always making the news for lawsuits tied to Countrywide mortgages, and the analysts knew how much funding they had allocated to pay for possible settlements -- therefore, they felt the stock was too risky to invest in. What I think they forgot is that the market is efficient, so those risks were already reflected in the stock price. Therefore, the upside to the stock was actually pretty good, but the analysts missed it.

What's the lesson here? Take analyst opinions with a grain of salt. They will have fantastic insights on the issues and opportunities for the company, but you need to make the final decision on whether the business strategy is sound and if that will lead to increases in earnings and, ultimately, stock price appreciation. You have to make the final call on how you feel about a company and whether or not you want to risk your capital investing in the stock. Once you have made your decision, be ready to read articles that oppose your decision. You will be pressured by your own mind to sell or buy, whatever is the opposite of what you actually did. If you did sound research and nothing has significantly changed since your assessment, give your investment decision time to be right.

Disclosure: I am long NFLX, BAC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.