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January 14, 2012

Can you benefit from “Analysts’ Stock Recommendations”

Jack Hough’s article in today’s “Wall Street Journal”, “How to Profit From Analysts’ Stock Recommendations”, provides food for thought.  Early in the article he states “…the historic evidence shows stocks with lots of “buys’ don’t do better than the broad market, on average.”  He notes a 1933 study by an economist that demonstrated “Stock forecasters can’t forecast with any accuracy.” 
Next the discussion notes that a paper published 16 years ago argued that the analysts’ recommendation could be beneficial.  There was an initial pop and then a gradual drift.  The key is to timely take advantage of the pops.  One key finding was: “…analyst recommendations are like dairy products in that it is best to use them quickly or not at all.”  A second key finding was: “‘sells’ tend to be far more prescient than ‘buys’. 
The article then moves to a working paper by three authors from three different institutions (University of Toronto, Virginia Tech and Cornell University).  The article theorizes “…that the best recommendations changes are ones… from concrete new information , and that changes in near term earnings for forecasts are a good sign of such information.” 
Another approach the article discusses is “…by using analyst math in reverse.”
The article seems to make a case that analysts’ stock recommendations do not provide much, if any benefit for long-term investors.  However, if you follow the daily recommendations, determine what information they are based on and act quickly you could develop a trading strategy to benefit from the recommendations.
The article suggests that the Dow Jones RBP U.S. Large-Cap Core Index follows a reverse math approach.

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