Anyone can predict the past
By Paul Price of Market Shadows
Our media-centric world continually exposes investors to a slew of information. Most individuals don’t have the expertise, or desire, to evaluate stocks on their own. They often trust opinions that they see on websites or hear while watching CNBC, FOX Business or Bloomberg channels.
Unless you understand how analysts operate you might over-value the advice. Researchers want to appear smart when appearing on TV or radio. The best way to do that, in a risk-free manner, is to explain what has already happened. That is much easier than predicting the future.
If a stock has just doubled in price, analysts justify the high price while implying they had recommended it when the shares were still cheap. Analysts often put ‘hot’ issues onto their buy lists after they’ve surged. They love to have people see BUY-rated, popular, good-performing tickers on their top stocks list.
Conversely, experts would rather explain why a stock has fallen sharply than defend buying something that has recently cratered. Pummeled shares are often bargain-priced but it is risky to defend bad looking charts.
Don’t just take my word for this. Here are three recent examples including Morgan Stanley’s October 29 upgrade on Nike (NKE). Morgan's client alert was republished in Barron’s Nov. 2, 2013 issue.
Nike was reset to OVERWEIGHT only after the stock made a new all-time high. After missing the move from $35 to $75, the analyst’s new target price ($85) is a mere 12% above the quote at the time of the opinion change.
Nike’s 10-year median P/E is 18x. The multiple at the time of Morgan Stanley’s upgrade (24.8x) was 38% higher than the 10-year median P/E based on the current earnings estimate of $3.05 for the fiscal year (FY) ending May 2014.
Morgan's valuation of NKE appears rich even if FY 2015 estimates are accurate.
Valuation-based services like Trefis and Morningstar, which rarely appear on CNBC, contend that Nike is overvalued. Trefis uses a sum-of-the-parts methodology to arrive at a fair value of $60.41. That is well below the current price of around $76. Standard & Poors values the company at $60/share using a very different technique. These valuations are based on rational metrics, not stock market action.
Cheerleading for companies making new highs is just one form of bad advice. Pulling BUY recommendations when previously favored stocks are experiencing selloffs is another.
Zacks watched good-quality industrial manufacturer Valmont Industries (VMI) decline by almost $30 per share before downgrading it from Buy to Neutral.
That call looked good for about 10 days. The shares reversed quickly and are now $7 higher than where they traded after the downgrade. Investors who listened to the trading alert missed a chance to purchase VMI as low as $129.
If you liked VMI at $165, why not love it at $135? If things were really bad, why wait for a big drop before deciding to get out?
Outright SELL ratings are hard to find. STRONG SELLS are even rarer. You might expect to see those only when stocks are sure to plunge.
Water Technology company Xylem (XYL) had been cruising along in a range from about $26 – $29 during most of 2013. An unexpected, poor quarterly report was released in late July and the stock gapped down below $25.
Standard & Poors wasted no time downgrading XYL to their worst-rated category after it was too late for traders to exit reasonably. S&P rushed to cut their estimates and price targets for both 2013 and 2014.
So did Brean Capital. After the damage was done, they changed their rating from BUY to HOLD while saying that fair value was really $22 – $25. The shares they had advised buying in the high $20’s were now deemed overvalued at $25.
In the very short run XYL did decline to under $24. Nobody who gave credibility to the analysts’ words would have dared to buy.
Did these analysts get their conviction plays correct since the July 30, 2013 downgrades? Xylem reported better than expected Q3 profits last week and ran up to an all-time high of $34.54 on Halloween. XYL closed last week at $33.22.
Do your own research to determine whether shares are Buys or Sells. You can’t get paid for what has already happened. In many cases that is all you are learning from changes in analyst recommendations.
Disclosure: Long VMI, Long XYL, No position in NKE.
