Investors often look to recommendations made by Wall Street analysts before making a Buy, Sell or Hold decision on a stock. While media reports about rating changes by these hired (or sold) brokerage firms often affect a stock’s price, do they really matter?
Before we discuss the reliability of brokerage recommendations and how to use them to your advantage, let’s see what these Wall Street heavyweights think. Ali Baba (DAD).
Alibaba currently has an average brokerage recommendation (ABR) of 1.27, on a scale of 1 to 5 (Strong Buy to Strong Sell), calculated based on current recommendations (Buy, Hold, Sell, etc.) made by 15 brokerage firms. An ABR of 1.27 approximates between Strong Buy and Buy.
Of the 15 recommendations that issue the current ABR, 13 are Strong Buys, representing 86.7% of all recommendations.
Brokerage recommendation trends for BABA
Check the price target and stock forecast for Alibaba here>>>
ABR suggests buying Alibaba, but making an investment decision based on this information alone may not be a good idea. According to some studies, brokerage recommendations have little or no success in guiding investors to select stocks with the greatest potential for price appreciation.
I wonder why? As a result of brokerage firms’ vested interest in a stock they cover, their analysts tend to value it with a strong positive bias. According to our research, brokerage firms assign five “Strong Buy” recommendations for every “Strong Sell” recommendation.
This means that the interests of these institutions are not always aligned with those of retail investors, providing little insight into the direction of future stock price movement. Therefore, it would be better to use this information to validate your analysis or a tool that has proven to be very effective in predicting stock price movements.
Zacks Rank, our proprietary stock rating tool with an impressive externally audited track record, categorizes stocks into five groups, ranging from Zacks Rank #1 (Strong Buy) to Zacks Rank #5 (Strong Sell) and is an effective indicator of stock price performance in the near future. Therefore, using ABR to validate the Zacks Rank can be an efficient way to make a profitable investment decision.
ABR should not be confused with Zacks Rank
Although both Zacks Rank and ABR are displayed on a range of 1-5, they are completely different measures.
The broker’s recommendations are the sole basis for calculating the ABR, which is usually shown in decimal numbers (such as 1.28). The Zacks Rank, on the other hand, is a quantitative model designed to harness the power of earnings estimate revisions. Displayed in whole numbers — 1 to 5.
It has been and continues to be the case that analysts employed by brokerage firms are overly optimistic with their recommendations. Because of the vested interests of their employers, these analysts issue more favorable valuations than their research would support, misleading investors far more often than helping them.
In contrast, the Zacks Rank is driven by earnings estimate revisions. And short-term stock price movements are strongly related to trends in earnings revisions, according to empirical research.
Additionally, the various Zacks Rank grades are applied proportionately to all stocks for which brokerage analysts provide earnings estimates for the current year. In other words, at all times, this tool maintains a balance between the five ranks it assigns.
There is also a key difference between ABR and Zacks Rank when it comes to freshness. When you view the ABR, it may not be up to date. However, since brokerage analysts constantly revise their earnings estimates to reflect changing business trends and their actions are reflected in the Zacks Rank quite quickly, it is always timely to predict future stock prices.
Should you invest in BABA?
In terms of earnings estimate revisions for Alibaba, the Zacks Consensus Estimate for the current year has remained unchanged over the past month at $8.86.
Analysts’ consistent views about the company’s earnings outlook, as indicated by an unchanged consensus estimate, could be a legitimate reason for the stock to perform in line with the broader market in the near term.
The size of the recent change in consensus estimate, along with three other factors related to earnings estimates, has resulted in a Zacks Rank #3 (Hold) for Alibaba. You can see the full list of today’s Zacks Rank #1 (Strong Buy) stocks here >>>>
Therefore, it may be prudent to be a little cautious with the equivalent Buy for Alibaba ABR.
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