Consensus Recommendation Screen: Is it worth listening to Strong Buys from Brokers?

Tuesday, Jul 19 2011 by
4
Consensus Recommendation Screen Is it worth listening to Strong Buys from Brokers

In Brief 

A recommendation level screen would focus on buying the most recommended stocks in the market based on the broker consensus. This is to be contrasted with a screen that focuses on those stocks most recently upgraded - a ‘recommendation revision’ screen. Overall, it appears that the absolute level of published stock recommendations has little (or even detrimental) value to investors, but monitoring the changes in investment recommendations can prove more productive.

Background

Broker recommendations as to whether clients should buy, sell or hold stocks  are widely reported in the media. Despite this, the value of these recommendations is hotly debated. The issue is that broker recommendations have historically exhibited a strong upward bias. Researchers Jegadeesh, Kim, Krische and Lee found that the average analyst rating over the 1985 to 1999 period was close to a buy recommendation and sell or strong sell recommendation made up less than 5% of all recommendations. This is because most sell-side analysts work for brokerage houses which often have strong investment banking franchises, creating a  potential conflict of interest when firms act as investment bankers to the companies their analysts cover. Following the debacle of the late 1990s, legislators have taken action to address this conflict. The US Global Analyst Research Settlement of April 2003, the EU’s Markets in Financials Instruments Directive of 2004 (MiFID) both targeted the fairness of research. Although this appears to have had some impact, recommendations still have remained relatively optimistic - research by Jegadeesh and Kim in 2006 indicated that analyst recommendations retain a significant element of favourable bias.  

Definition of a Consensus Recommendation Level Screen

A somewhat simplistic screen based on pure recommendation levels might, say, buy the most favorably recommended quintile of stocks according to the consensus, and sell the least favorably recommended quintile of stocks. 

Does that work?

The evidence is mixed but most research suggests that it doesn't, especially after transaction costs and assuming a more medium term investment horizon. Early work by Womack did find short term excess returns (3-5% over a three day period) as well as longer term post recommendation drift.  However, Barber et al found that, while a trading strategy was profiltable before transaction cost, returns after taking into account costs were insignificant.  Furthermore, a subsequent paper taking into account the…

Unlock this article instantly by logging into your account

Don’t have an account? Register for free and we’ll get out your way

Disclaimer:  

As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested. ?>


Do you like this Post?
Yes
No
4 thumbs up
0 thumbs down
Share this post with friends




What's your view on this article? Log In to Comment Now

You can track all @StockoChat comments via Twitter


About Stockopedia Features

Stockopedia Features

Stockopedia Features covers in-depth stories on strategies, companies and themes that are relevant to online investors. Investing is hard work. We don't try to over-simplify complex concepts - we prefer to try to help you navigate the detail.  more »


Stock Picking Tutorial Centre



Let’s get you setup so you get the most out of our service
Done, Let's add some stocks
Brilliant - You've created a folio! Now let's add some stocks to it.

  • Apple (AAPL)

  • Shell (RDSA)

  • Twitter (TWTR)

  • Volkswagon AG (VOK)

  • McDonalds (MCD)

  • Vodafone (VOD)

  • Barratt Homes (BDEV)

  • Microsoft (MSFT)

  • Tesco (TSCO)
Save and show me my analysis