Investing isn't easy. And for Wall Street analysts, having public "buy," "hold," or (rarely) "sell" ratings on specific stocks is challenging--and sometimes embarrassing. But an all-too-familiar pattern of behavior by Wall Street analysts is happening again—with likely negative consequences for investors.
There is so much career pressure on these extremely well-paid analysts that they tend to move as a herd. (Just as fund managers often “hug” the benchmark market index they are measured against in order to produce returns comparable to the major stock indexes.)
Unfortunately, the analysts often move after the fact, which doesn't help investors who follow their advice. It is common for analysts to downgrade their ratings and price targets on a company’s stock after bad news is issued by the company (such as a profit shortfall). The problem is the stock price plunges immediately when the news is announced, so it is not possible for investors to heed the advice to sell without taking a major hit to one's proceeds. Or, after a stock has fallen steadily even without a specific news announcement, analysts often give up on it and either cease coverage of the stock or downgrade their rating.
Similarly, the "bandwagon effect" is common with a rising stock. Everyone loves a winner, and a stock that has been a great performer attracts many fans. The supposedly objective Wall Street analysts seem to get just as carried away on the way up--and down--as the broad investing public. Take Apple. Just last summer, as Apple prepared to launch its latest version of the iPhone, there was frenzy interest in the company and its stock. Only four months ago, the stock reached a record of $705 per share. Almost all of the 50 or so analysts covering the stock rated it a "buy” (after it had risen % over the past three years). The Wall Street stock analysts seemed determined to outdo each other with their optimistic price targets for the stock, with some exceeding $1,000 per share. (In contrast, go back to my blog at LehmanInvest.blogspot.com/ and read my warnings about the stock at that time.)
Today, the stock has fallen nearly 30% from its peak, perhaps because of concerns about the profitability of the iPhone5, perhaps because of investors selling shares to book capital gains in advance of higher tax rates. Who knows for sure? The stock is simply down sharply. But in response, today another analyst sharply lowered his price target on the stock (from $660 to $530), after the 30% drop in the stock. Apple stock now sells at 10.5 times estimated earnings per share this year, a sharp discount to the overall stock market. Apple remains one of the world's leading companies, and it is in superb financial condition.
I am generally not a fan of investing in technology companies for a couple of reasons. One, I don't understand the products. Two, technology products can become obsolete virtually overnight, so from a business standpoint, they often don't provide a "margin of safety." But when the stock market is undervaluing a company's stock based on its asset value, earnings, or especially its generation of cash beyond what is needed for normal business operations, I'll consider investing in it.
And even though I think that stock prices in general have risen so sharply--along with enthusiasm among investors-- that makes a decline likely, relative to other stocks at the moment, I would more likely buy a stock like Apple than one like Celgene. Celgene was upgraded to "buy" today by a Wall Street analyst after the stock rose 16% last week (and 36% in the last two months) on the basis of positive drug test results. After all, we want to buy when there is good value in a stock, before a sharp rise in the stock price and sell when there is no longer good value, before a sharp decline in the share price.