Every brokerage firm on Wall Street has a team of analysts dissecting every available piece of information on individual stocks. As a general rule, stock analysts are assigned a sector, industry, and stocks within each sub-industry. Larger brokerage firms employ full teams of analysts researching single stocks or small baskets of stock. Away from the Wall Street spotlight, analysts work at local banks and insurance firms.
People who dream of a career in financial services see the analyst profession as the top tier of the ladder. Thousands of applicants apply each year to become interns for Wall Street brokers. Some of the top analysts have spent their entire career working for the same company dedicated to a specific sector or industry.
Investors who do their homework check the analyst ratings on a company for other areas to investigate. Some traders base their entire strategy around a particular grade and the bounce a stock will get if that rating is better than average. When an analyst upgrades, stock investors look to buy or sell short, knowing a spike (up or down) is coming.
Buy, Sell or Hold
Every brokerage firm has their stock rating system each analyst is expected to follow. Once the rating is set, the analyst documents their opinions. Most firms follow the same guidelines.
- Buy: Buy, or strong buy rating means the analyst feel the stock is in a range to begin to accumulate or add shares. Most firms have an overall recommended buy list.
- Sell: The analyst says to sell or strong sell a stock. It is time to sell a portion or liquidate the entire position of the shares you own. A firm adds the stock to their overall sell list.
- Hold: If an analyst places a hold on a stock, the analyst is saying not to add any shares at the current price. The stock is expected to perform in line with the overall market. These stocks are not considered candidates for day trading.
- Underperform: With an underperform designation, the analyst can also mean weak sell or weal hold. The analyst is saying the stock will perform less than the overall market for a given period.
- Outperform: This designation can also mean moderate buy, accumulate or overweight. The stock is marked as outperform if the analyst believes the firm will perform slightly better than the overall market.
Analyst Upgrade or Downgrade
Analysts will upgrade a stock in their designated sector or industry if there is a fundamental change in the way a company is conducting their business. As an example, the company has discovered an exciting new product that will add a significant revenue boost in the next 12 months. Alternatively, the company invested in a new piece of equipment which reduces the overall cost to produce their widget in the next 24 months.
Conversely, if the analyst sees a drop in the earnings-per-share numbers in the next quarter, they may reduce the designation to hold or underperform. If the analyst feels a company will underperform the market significantly in the next 12 or 24 months, he will place a sell or strong sell on the company.
There are three forms of investment technique in the stock market: technical, fundamental, and a combination of both. Technical analysis deals purely with price action. Fundamental investing looks at the company’s financial performance over time. A combination of both disciplines will use fundamental techniques to screen for stocks and technical analysis to time an entry.
An investor chooses how they want to invest in the markets based on their aversion to risk. The individual small investor cannot compete with the traders and sharks on Wall Street. The adage, “they see you coming” is no more meaningful than trying to beat one of the major indexes.
The last market bubble burst and millions of investors lost their savings by thinking a day-trading life was for them. The Federal Government stepped in to curtail some of the shark-like tendencies of Wall Street investment firms. No more than five-day trades can be made without proper capitalization, and other curbs were finally implemented to protect the small investor.
The use of an analyst recommendation should be used in a broad context of investment in the markets. Investors must know their appetite for risk.