By Neda Jafarzadeh, a financial analyst with NerdWallet Investing. NerdWallet Investing helps consumers make better financial decisions, like finding the best Roth IRA account provider for their needs.
Investors everywhere take advice from Wall Street analysts who issue buy, sell, or hold ratings on a given stock – but how accurate are these ratings and should investors be following these recommendations? According to a recent NerdWallet Investing study that investigated all 883 stock ratings issued on the Dow 30 in 2012, only 51% of these analyst ratings were correct in 2012. However the study also found that allocating a portfolio proportional to analyst ratings would have outperformed the Dow 30 by 4.1%.
Some Key Findings
To gather its findings, NerdWallet Investing studied Wall Street analyst recommendation on the 30 stocks in the Dow Jones Industrial Average over 2012. The study found that the distribution of analyst stock recommendations was 62% in favor of “buy” ratings with the rest being 34% “hold” and 4% “sell”. It’s interesting to note however that the buy ratings largely contributed to the number of ratings that were actually correct.
With over 70% of buy ratings correct, buys made up about 85% of all accurate ratings. On the other hand, hold ratings, where the majority of the other recommendations were distributed, performed rather badly with only 20% of them performing as expected. In short, it seems research analysts are better at picking stocks that will outperform the market.
Who are these research analysts and what do their ratings mean?
Research analysts are mostly employed by large investment banks in order to cover a set of companies for regular issue buy, sell or hold recommendations. Issuing a buy rating essentially means that the analyst expects the stock to outperform the relevant market index. A hold rating implies performance similar to the market while a sell rating indicates a prediction that the stock will underperform the market.
Who buys these analyst reports? Typically investment managers and hedge funds use it.
The Takeaway for Casual Investors:
If professional analysts have trouble stock picking, it goes to show that casual investors will too – most investors would see better returns by buying and holding low cost mutual funds and ETFs. To help make it easier, NerdWallet’s Mutual Fund Screener allows investors find and compare the best funds for their portfolio.