Investors often rely on Wall Street analysts' recommendations when making Buy, Sell, or Hold decisions about a stock, but do these ratings truly matter? Let's examine the credibility of brokerage-firm employed analysts and explore how to use their ratings to one's advantage.

Brokerage Recommendations: A Misleading Guide for Investors?

Brokerage firms employ analysts who issue ratings on stocks that often influence investors' decisions. However, several studies have shown limited success of these recommendations in guiding investors to pick stocks with the best price increase potential.

This anomaly can be attributed to the vested interests of brokerage firms in a stock they cover. These analysts tend to rate it with a strong positive bias. Our research reveals that brokerage firms assign five "Strong Buy" recommendations for every "Strong Sell" recommendation, indicating their interests aren't always aligned with retail investors.

Furthermore, brokerage analysts' ratings often reflect the optimism and biases inherent in their role within a firm. Their job security may depend on maintaining good relationships with clients and producing results that benefit their employer. This conflict of interest leads to more favorable ratings than research would suggest.

Zacks Rank: A Proven Indicator for Stock Price Performance

Zacks Investment Research has developed the Zacks Rank, a proprietary stock rating tool with an impressive externally audited track record. This model categorizes stocks into five groups, ranging from Zacks Rank #1 (Strong Buy) to Zacks Rank #5 (Strong Sell), effectively indicating a stock's price performance in the near future.

When using the Average Brokerage Recommendation (ABR) to validate the Zacks Rank, it becomes an efficient way of making a profitable investment decision. The ABR displays the current rating from brokerage firms on a scale from 1 to 5, typically in decimals, whereas the Zacks Rank is displayed in whole numbers.

Key differences between ABR and Zacks Rank:

• Source: The ABR is based solely on brokerage recommendations, while the Zacks Rank relies on earnings estimate revisions.
• Freshness: The ABR may not always reflect current market changes due to its reliance on past ratings. In contrast, the Zacks Rank quickly adapts to changes in a company's earnings prospects.
• Objectivity: Analysts' interests are factored into the ABR, making it less reliable for predicting future price movements.

Validating your own research with Zacks Rank

The best use of brokerage recommendations might be as an additional indicator that complements other sources. By comparing the Zacks Rank to the individual analyst ratings listed in Table 1 and 2 above, we get a sense of the confidence level behind each recommendation, which ultimately helps investors make better-informed investment decisions.

In conclusion, investors should approach Wall Street analysts' recommendations with caution and utilize them as a complementary tool for their own research. By combining Zacks Rank with their individual research efforts and other indicators, people can have a more informed understanding of a company's potential stock value.