Study: Investors could be misled by analysts’ recommendations10/05/2015
COULD INDIVIDUAL INVESTORS be misled by equity analyst recommendations?
Yes, according to University of Akron Professor of Marketing William Baker, Ph.D.
In their paper, Equity Analyst Recommendations: A Case for Affirmative Disclosure?, published in the Journal of Consumer Affairs, Baker and colleague Gregory Dumont, Ph.D., suggest analyst recommendations have no predictive validity.
“This in-depth analysis of brokerage analyst buy, sell and hold ratings in the Dow Jones Industrial Average and the S&P Technology Sector over a 14-year period from 1999 to 2013 revealed that equities with hold ratings consistently outperformed equities with buy ratings,” Baker says.
The paper, which reports findings of three studies, reveals that investors who rely on professional analysts could be misled by compromised financial information. Potential causes include pressure by managers, their firm’s investment banking clients and,other large institutions such as mutual funds. Other causes include herding (following the lead of other analysts) and decision-making biases. Regardless, the results suggest that investors who use these recommendations are making compromised decisions. Concerns regarding analyst accuracy are not new.
“When the percentage of analysts’ buy vs. sell recommendations reached 74 percent and 2 percent, respectively in the mid-2000s, regulator scrutiny intensified,” Baker explains.
Selected in 2014 as a finalist-of-the year by the Journal of Consumer Affairs, the paper underscores conflicts of interests that form biases among analysts who are often pressured to provide overly optimistic guidance to investors.
Baker points to previous research that found this pressure comes from in-house management seeking to secure more banking business. Also, managers of covered firms could lock out analysts who provide guidance deemed as too low. Likewise, managers of pensions and mutual funds seek positive outlooks for stocks that heavily weight their portfolios.
Risk for retail investors
While there is no shortage of investment-guidance options, analysts are the sole advisers financial and government licensing agencies deem as “expert.” Consequently, retail investors who rely on these analysts’ guidance for their investment decisions could be misinformed by biased recommendations.
Baker recommends affirmative disclosure as a remedy for investors that would enable them to determine the value of analysts’ recommendations.
“Ultimately, affirmative disclosure promotes transparency and represents a balancing mechanism through which all investors will better ascertain the relative an historical value of each analyst’s ‘expert recommendation,” the paper states.
Dr. William Baker