Achieving returns that beat the market is the never-ending quest for investors who scour their resources looking for an edge. Most people dismiss Wallstreet analyst estimates as overly biased towards the long side, whether because they’re paid to or it’s easier to. Yet, outliers exist where following the analyst recommendations repeatedly produced better results than buy and hold. Using the StockMetrix App, the backtested data below highlights 10 stocks that provided highest returns by following Zacks analyst estimates:
The backtest involved looking at the S&P 500 data and scaling in and out of positions based on the price relative to the analysts’ price target minimum, average, and maximum. The results yielded 172 out of 496 that beat the buy and hold strategy. The top ten provided annual returns anywhere from 0.23% - 3.65% higher. Keep in mind some of these companies, such as Facebook, only recently entered the S&P 500. Many oil and gas companies fell out over the last several years as crude plummeted. This creates a survivorship bias worth noting.
What Leads to an Edge?
Looking at some of the largest winners in this list, the number of transactions vs the excess returns comes to the top of the list. CNC by far has more transactions by a factor of nearly 3x than any other. The stocks with fewer than 10 transactions typically have less than 1% edge. However, stocks like ABBV with 15 transactions provided the smallest advantage over buy and hold. While there appears to be some correlation, it’s not a very strong one. Having a high number of transactions highlights either constantly changing analyst sentiment or large price swings. Given that CNC’s beta (measurement of volatility relative to the S&P 500) of 0.76, the former is more likely. Keep in mind that different companies had different amounts of data available. Those with more time available typically had more transactions, with some exceptions. Further, catching the right years in the backtest can significantly alter the results. SPGI only has 2 years worth of data, yet shows in the top 10 list. If the time frame expands it becomes increasingly likely that given its newness the edge will wax and wane depending on when the tests are run.
Why Did Analysts Get THESE Right?
Reviewing the stocks, it’s almost impossible to see anything fundamental the companies have in common. They range from social media to credit cards, from health insurance to oil refining. Some have extremely global presences, while others are strongly tied to the US economy. Using the data provided by the Stockmetrix app, an easy comparison of revenues, earnings, and other fundamental data doesn’t highlight anything notable either.
The answer most likely exists in the non-answer here. Recall that 500 companies comprise the S&P 500. Analysts cover these stocks to varying degrees, but all have some coverage. If analysts have 496 chances to get it right, getting 172 right out of 496 means only being effective 34.7%% of the time. On top of that, they’re barely effective by more than 1% than just buying and holding a stock. Digging deeper into the results, some years had sizably higher beats and some had significant drags. In 2018 ABBV compounded annualized rate from analysts measured from January until late April came in at -49.6%. During that same period buy and hold would have annualized half that. Fundamentally, when applying backtests, the time frame chosen can often lead to false positives. In this particular case, with large negative years and large positive years all mixed together, there doesn’t appear to be a smooth equity curve that would indicate a sustainable strategy.
Conclusively, It’s Exactly What You Thought
Analyst opinions cannot be followed blindly for their recommendations. Unlike weather forecasting where an ensemble of models produces a more accurate model, averaging analysts just averages out any useful information. But by no means should analyst opinions be thrown out. Rather, analyst opinions individually provide useful insights and ideas that an investor wouldn’t otherwise come on their own. Analysts spend their days looking at companies forwards and backward, knowing all the ins and outs of what has, is, and will likely happen. Their analysis decouples from reality when trying to predict stock prices. Analysts opinions and their research provide invaluable knowledge to investors. They just must be understood in the proper context for what they are.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.