POINTS FOR CONSIDERATION BEFORE ANALYZING SELL RECOMMENDATIONS
Due diligence in equity trading is an intricate and tedious process. Many traders turn to analyst recommendations to decide whether to purchase or sell stocks. But studies show not all research analysts are accurate, which are attributed to different factors such as the complexity of the job itself or conflicts of interest.
No one has the power to predict the future. Also, several elements are accounted, making the task harder. Numerous analysts trail many huge companies. Two things: forecasts for entities are not that precise and communal projections for a particular time period may vary depending on economic data, fundamentals, and latest news.
A Star Capital research, encompassing over 1.5 million estimates, unmasked there was a 30% error in forward-12-month estimation among German analysts from 1975 to 2008. A McKinsey study indicated too much bullishness between 1985 and 2010, recognizing the limitations of an analyst research.
Some professionals accept incentive in return for estimates. Facing greater pressure to come up with optimistic reports, expert guidance has played a vital role in determining the demand for a firm’s shares. Therefore, to earn incentives, they need to publish excessively bullish projections to keep prospective clients satisfied. Investors do not ascribe to dull or neutral views or suggestions; hence, the necessity to embellish stories to beef up investor interest and trading. Not to mention analysts could own stocks directly or indirectly.
The Securities and Exchange Commission has endeavored to curb these incentives at the very least. Although the agency has somewhat managed to balance the risk-reward proposition among analysts, investors should remain mindful of conflict of interest.
Speaking of which, investors have various resources to gauge if a specific sell recommendation is extremely bearish or bullish. Some of those include consensus estimates, earnings insights, and historical data.
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