We debated posting this and decided readers interested in Wall Street really should get a solid understanding of what it all really means. Before reading the full post.
“Delete Every Single Article About How Ratings Mean XYZ, They Are Practically Meaningless!”
To all the financial studies done out there on ratings being “poor” to them we say you are 100% correct… Because the Street is misunderstood. Analysts get paid indirectly to put CEO’s and CFO’s in front of buy-side clients. So this should already tell you something… If you see a “sell rating” that means “Run Mother Fucker Run” management/the entire company is in a downward spiral. Now imagine we ask the CEO to come “to a meeting with buy-side clients”… the CEO will unlikely want to attend a meeting where we are telling large investors to short sell the stock (bet against the company) hence driving his company value down. Unlike the black and white performance of sells and buys that yahoo finance spits at you, Wall Street is never as simple as it may seem, so you will see a positive rating bias.
Finally, the best part about a “hold” stock. You can tell buy-side clients to get long or short for shorter durations call it 3-6 weeks or months, now you can make the buy-side happy by making them money and most CEO’s are reasonable enough to understand they have better entry and exit points. If they did not believe this the company would never participate in company stock buyback programs (where the company essentially times its own stock to repurchase shares and lowers their share count which increases EPS) because that would mean the stock is always going to go higher and never have a pull back. Hopefully this was a quick enough summary to get an idea of what the 3 ratings really mean. But I’ll give the rundown below for a quick reference:
Buy: Positive bias long-term, so the company might be a decent company to hold onto for the long term. Take with a grain of salt if this is a rating on a large cap stock ($10+ billion) with a substantial long-term relationship with the investment bank (see disclosures in their reports). As a rule of thumb look at buy ratings as “neutral to up” so 0-10% return. If the company really is good they will likely distinguish with a “strong buy/best in sector or other rating above “buy/outperform”. As mentioned earlier the sell-side wants good relationships with CEOs so if a certain CEO is arrogant, you may see analysts rate it as the greatest stock… in history. You get the idea.
Hold/Neutral: Being dead honest, to us this likely means sell and take your profits. There are times however, when you see a company with a high-risk profile that’s up at a high valuation that you call neutral. But simply put you are telling clients to take profits. We’re not saying the company is dying, we’re not saying the management is bad, we’re saying the company itself likely wouldn’t buy back shares at these levels. A good rule of thumb, “you can like a company and not like the stock, you can also like a stock and not like the company”.
Sell: This one is an easy write up… run, run as fast as you possibly can away from this company. If you see net sell on a stock, please liquidate your position, fast. If this doesn’t make sense, I’ll reiterate that management of this company would never sit in a meeting where you essentially tell everyone to “get short the stock and run their stock price down into the ground”.
Conclusion: Yes ratings matter, however they are never clean ratings because you want the company to like you as a person, you don’t make friends with management teams by telling them they are the next Enron. It’s called the sell-side for a reason. Finally, the smart guys reading this article are probably wondering how do I know what the analyst is “really thinking”. Simple. Call them.
