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For instance, on CNN Money if you go under forecasts for any semi-large or larger company you will find the number of buy/hold/sell ratings. Is there any way to find out if over a long historical period stocks with a buy rating (from most analysts) outperform stocks with a sell rating?

For example, if I made a portfolio that exclusively consisted of stock with many buy ratings, would this have outperfomed the S&P 500 historically?

Basically I am looking for an empirical answer but I can't find any on Google.

Hisham Hijjawi
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  • Basically I am looking for an empirical answer but I can't find any on Google There is your answer. If there aren't any results means it ain't happened yet. – DumbCoder Jan 09 '20 at 08:47
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    @DumbCoder If enough people upvote the question, we might get an answer that isn't publically available yet. – Hisham Hijjawi Jan 09 '20 at 09:02
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    In an efficient market, the stock price already factors in expected future growth. If an analyst issues a "buy" rating, that means they are predicting higher growth than the rest of the market is predicting, i.e. the stock is worth more than it's currently being traded at. But once that rating becomes public, the public can also factor in this advice and the advantage from following this advice is erased (if such an advantage ever existed). So you can only get above-average results if the market is inefficient, or if your investment goals differ significantly from other market participants. – amon Jan 09 '20 at 09:49
  • @amon Very true, but doesn't give an empirical answer. I do hypothesize that an index comprised of buy rated stocks is more efficient than a general market. I just want to be able to prove it. Many investors lack the knowledge of a professional analyst, hence the hypothesized inefficiency. – Hisham Hijjawi Jan 09 '20 at 21:06
  • @amon I believe this is not exactly what OP is asking. Your premise is that the market somehow uses the analysts ‘special knowledge’ and it gets baked into the stock price. What I believe OP is really asking is if the analysts somehow outperform the market - and if there exists some empirical evidence of that. – ssn Jan 10 '20 at 08:48
  • When I read the question my immediate answer was "of course not, no analyst outperforms the market".... But seeing how groups of people tend to make decisions far better than individuals and "a majority of analysts" which could differ from one stock to the next could be far better than any single analyst could ever do.... I don't think you'll get an answer because I don't think anyone aggregates this data, but it's interesting. – xyious Jan 10 '20 at 21:12
  • @xyious The more people who upvote the question, the more likely we are to get an answer :) I've been trading for 15 years now, and I know that confirmation bias is real but in my experience an aggregate of analyst views does beat the market because in general fund managers don't listen to analysts. – Hisham Hijjawi Jan 10 '20 at 21:19

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Like everything in life, there are good analysts and there are bad analysts. Good ones can hit a bad streak and bad ones can hit a good streak. The only way that you're going to have a shot at succeeding with your premise is if you track the analysts and collate a track record.

Also, be advised that research analysts at fool service brokers have multiple conflicts of interest. Just because they say Buy, doesn't mean that it's really a good buy.

Bob Baerker
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Sorry I don't have citations, but I worked for Fidelity for many years and I can assure you that the average fund at Fidelity underperformed the market. Only the superstar funds tended to outperform the market, and the constellation of superstars was constantly changing.

Also, don't trust "index funds". Index funds do not actually track the market because when bankruptcies occur the fund suffers, but the index does not. For example, let's say IBM drops below $1 per share and gets delisted. Then what happens is that IBM is IMMEDIATELY removed from the index, however, everybody who holds IBM usually suffers the $1 to $0 drop because they freeze trading in a stock when those things happen. So, basically what this means is that whenever a company fails, the equity holders get screwed, but that drop to zero never shows up in the index. So, the index is an artificial construct that does not represent investment reality.

Five Bagger
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  • Upvoted the answer, but I don't think this answers the question. Fund managers don't necessarily choose the stocks that are highly rated by analysts. – Hisham Hijjawi Jan 10 '20 at 08:01
  • I don't agree with your premise. While IBM is in the index and is failing, the index reflects the loss. If trading is halted, the index ETF is subject to the same risk as the share holders (neither can trade IBM). If IBM resumes trading then both parties can exit IBM. Neither one is disadvantaged. If IBM is removed from the index, there is no longer a co-dependent relationship with IBM's price and IBM's price is irrelevant. The index reflects the price of IBM at all times until removed from the index. – Bob Baerker Jun 08 '20 at 18:44
  • @BobBaerker I don't think you understand what I said. I didn't say anything about individual shareholders. I said that index funds can't track the index. The reason I gave above is only one reason why index funds don't actually perform the same as the index. There are actually multiple other reasons as well which are more technical. – Five Bagger Jun 08 '20 at 20:04
  • I didn't say anything about individual shareholders. Really? Then what does this mean? --> ...everybody who holds IBM usually suffers the $1 to $0 drop because they freeze trading in a stock when those things happen.** And then this --> So, basically what this means is that whenever a company fails, the equity holders** get screwed, but that drop to zero never shows up in the index.** So either you're contradicting yourself or your framed your answer very poorly. – Bob Baerker Jun 08 '20 at 20:14
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For example, if I made a portfolio that exclusively consisted of stock with many buy ratings, would this have outperfomed the S&P 500 historically?

Lets say this is a great idea. You decide that is your path forward, and you start to assemble the portfolio. At first it is easy, just pick a bunch of stocks that have a large number of buy ratings. Then time sets in. Every time new quarterly reports come in, opinions change. Highly rated stocks become neutral or shift to sell. Stocks that used to be sell are getting more buy ratings.

You now have a active fund. New opinions come in every day, so the list of stocks you should be buying or selling change. Of course you are only buying after market experts have said buy, so you missed out on the initial rise. You are also selling after the stock is viewed as struggling, so you missed out on avoiding the initial decrease.

Long term active funds that chase the popular trends do worse than the S&P 500.

mhoran_psprep
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