Stock analysts have been around for a long time, and social media has made them more well-known than ever before. These analysts are always providing forecasts and sharing their opinions about the market’s future. Should you listen to them, and are their forecasts even reliable?
Stock forecasts are unreliable because the outlook is limited to one year. Some analysts also have a vested interest in the companies they cover. You should listen to stock analysts, but only to compare their analysis to yours. Never base investment decisions purely based on their guidance.
The rest of the article will look at why you should not rate the opinions of stock analysts too highly and why the forecasts they provide aren’t always reliable.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
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Why Stock Forecasts From Analysts Are Not Reliable?
As a newcomer to the investing world, you may be ecstatic at the sheer amount of predictions around share price, revenue, earnings per share, and trend projections all over the internet and on TV. You may feel like the “experts” have done all the work and just follow their lead.
Unfortunately, this is an approach that’s sure to leave you counting your losses.
Although analysts are highly paid experts with social clout, their forecasts are usually not worth more than the opinion of a random bloke hiding behind a cartoon profile picture on Twitter for various reasons. The following explains why stock analysts’ forecasts are not always reliable:
Stock Analysts Have a Vested Interest
Analysts do not make these forecasts because they care about you, the average investor, and want you to make money. In many cases, they are only earning their keep. Some of the companies the analysts work for include brokers, index fund companies, and hedge funds.
Analysts employed or earning commissions from brokers will often make forecasts that favor the brokers more than investors. The regulatory agencies have tried to counter this through laws like keeping sell-side analysts away from brokerages. However, that has not changed much.
Those employed by index funds make forecasts on assets that are beneficial to their employer’s portfolio instead of giving an unbiased view of the asset’s direction. Similarly, analysts employed by hedge funds make biased forecasts that favor their employers to the detriment of retail investors. You only need to look at the GameStop, AMC debacle to see how far hedge funds are willing to go to beat retail investors. Hiring a few popular experts is nothing to them.
So, these guys simply do not work for you and are more incentivized to make biased or even false predictions if it serves the purpose of their paymasters.
Stock Analysts Are Usually Wrong
It is common sense to expect a professional who has spent years in his field to always be right with their actions or inactions (or at least have a high success rate). However, that logic flies out the window with stock analysts.
Most of their forecasts are nowhere near as accurate as you would ordinarily expect.
According to statistics from FactSet.com (link in article sources down below), most publicly traded companies beat the expectation of stock analysts on their financial reports. In just the final quarter of 2020, more than 80% of S&P 500 companies reported a positive surprise in their earnings per share, beating analysts’ expectations, and 79% of companies also beat their expectations on revenue.
These are key metrics most investors analyze, and interestingly, more than 80% of analysts failed in their forecasts on them. If they can fail so spectacularly on the basics, why should you listen to them?
Away from documented statistics, you only need to count the number of designer-suit-donning analysts on Twitter and other social platforms that forecast tops and bottoms for a wide range of financial assets and see how many end up being wrong at the end of the day!
Stock Forecasts Are Usually Short-Term
As an average investor, you need to think long-term to build wealth in the stock market. The most successful investors think in years or decades when evaluating market performance.
Stock analysts, on the other hand, typically follow a yearly timeframe with their predictions. A stock that looks like a good bet for the next 12 months could take a tumble in the longer term.
Short-term forecasts are also generally affected by short-term market volatility, making them unreliable. You only need to look at how the COVID-19 pandemic disrupted the markets and invalidated forecasts for the year 2020.
Most of the affected stocks quickly made a strong recovery as the world continued to recover from the pandemic. Still, anyone who acted on analysts’ forecasts would have been in a deep drawdown between February and July 2020.
When You Should Listen To Stock Analysts?
As seen thus far, forecasts from analysts are unreliable. However, you should not entirely discard them. There are scenarios where stock forecasts from analysts can prove useful to you as a retail investor. Consider listening to stock analysts when:
You Need Support for Your Research
“Do Your Own Research” is a common mantra in the investing and trading world. However, there are times when the research might feel undercooked, leaving you seeking validation. Going through analyst forecasts is a good way to find it.
Their predictions are unreliable, but if your research agrees with what most of the forecasts are saying, there is a high probability that you are on the right track overall.
If your research goes against the consensus, you may still be onto something the rest of the market does not know about. Either way, it is good to see what other people think AFTER you have drawn your own conclusions.
You Suspect a Stock Is About To Take a Plunge
As mentioned earlier, analysts are generally biased when it comes to stocks they cover, always making positive forecasts around them. Therefore, if most analysts covering a stock you suspect is in danger of crashing are calling a sell, that is confirmation that something is wrong with the company’s health.
You Are Looking for Stocks Gaining Traction
Analysts only publish forecasts for stocks people have shown interest in. They do this because they want their opinions to go far and wide. So, the number of analysts covering a stock is a good indicator of the stock’s popularity.
You should take note if you find a few analysts suddenly offering opinions on a stock you have never heard of. Their filters may have already flagged the stock as the next big mover over the coming months.
Tips on Researching Your Investments
At this stage in the article, you may have lost your enthusiasm towards stock forecasts and analysts in general. If you already know how to do your own research, you’ve likely concluded to only listen to your analysis. So, what happens if you don’t know how to research your investments?
Speak to a Financial Advisor
Financial advisors are bound by law to give you the best possible advice for your situation. They will recommend fund managers that can either make trading decisions on your behalf or offer trade recommendations you can rely on while you continue to learn how to make your own forecasts.
Invest in an Index Fund
It is well documented that most fund managers do not beat their benchmark index. You may be better off sticking with an index fund tracking the S&P 500, for example, and taking the average annual return of 10%. It is more return than you will get blinding following biased analysts or following your gut.
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Conclusion
Stock forecasts and the analysts that produce them are an integral part of the finance world. However, these forecasts are not always reliable. You should not base your investment decision solely around them. At best, they should only serve as a rough guide for when you need extra confirmation for your own research.
If you find yourself paying too much attention to analysts, there is a high probability that you are not yet ready to start managing your investments on your own.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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