Whether the stock market is on a raging bull market or going through one of its common corrections, there are analysts hard at work. They cover individual stocks, bonds, funds and the entire market as strategists. While most analysts share the same goal - to evaluate the investment worthiness of a company - their methods and practices can vary widely. Analysts also tend to bunch up their coverage on large and popular stocks, leaving little room for a company to surprise the market with uncovered news. It also leaves many companies open for discovery. If most of the analysts are covering the big stocks, it's up to the smart investor to find the next undiscovered stock. (Thinking about relying on analyst recommendations for your next trade? We'll show you what to watch out for. For more information, read What To Know About Financial Analysts.)

The Business of Analysts
Analysts can work on the buy side of the business evaluating companies for their own use and selling their research to the market. Sell side analysts on the other hand, typically provide insight to the buying public and can often have some vested interest in the company they are touting. Either way, both types of analysts spend the majority of their time digging through financial statements and earnings reports. Unfortunately for the average investor, there seems to be no rhyme or reason as to how an analyst chooses what companies or why they choose that path. They have also been faced with deciphering a broad array of analyst opinions as many companies have moved away from the traditional "buy" and "sell" ratings of the past. (Find out more in Analyst Forecasts Spell Disaster For Some Stocks.)

Coverage
Anyone who spends time reading investment research reports knows how much attention some stocks get. Like a popularity contest in high school, it is inevitable that analysts for the buy and sell side gravitate toward the most popular stocks. Unless an analyst is assigned to that sector or is considered an expert on that company, the choice can be for many reasons. There has always been some connection between market capitalization and analyst coverage, so it is inevitable that large companies like IBM and Exxon will always have in-depth coverage.

Here are some examples of the number of analysts covering some of the larger stocks in January 2010:

Company Sector Market Cap (billion) # of analysts covering
IBM Technology $175 22
Exxon Energy $325 19
GE Capital Goods $175 14
Microsoft Technology $280 30

So why are more than 20 different analysts needed to cover one company if companies are not allowed to provide any insider information to anyone? You also have to wonder how much analytical work one would need to actually do if so much has already been done. One of the problems with so many analysts is that there are certain times in economic cycles when because of uncertainty, many analysts estimates fall within narrow ranges. This can be particularly odd as many analysts tout their earning estimate models as being better than the rest. While this is a little suspicious at times, the quarterly reported numbers are often close to the average of all the analysts' estimates.

While this makes the analysts look like they are doing a pretty good job of covering these companies, how can they really add value? You can't pick up a financial newspaper or turn on the financial news without hearing about "earnings surprises". That's because earnings surprises can drive a stocks price movement up or down. If all the analyst does is report the publicly available news, you might as well just buy the company and ignore the analyst. The good analysts who dig deep into research do add significant value, but you have to read beyond the headlines. Although analysts implement superior models and further research than what is common to the every-day investor, analyst estimates are often immediately reflected in the share price of the covered firm. (To learn more about earnings surprises, read Surprising Earnings Results.)

The Ratings System
As recent as the technology bubble, most analysts were using more simplified ratings like the old formats of simply buy or hold. This was very straightforward and easy to understand, but this also left too many variations of buy and sell up to interpretation. This was even more apparent as the investment banks taking the new stock public stamped a buy rating on that stock.

While some firms still stick to the straight forward buy or sell, many have changed to a more complicated system of numbers, letters and ratings such as "strong buy". You can see "initiate coverage," "market perform," "market underperform" or even "neutral" as a rating. The numbers and letters are a little easier to read and more black and white. For the average investor, here is a good rule of thumb: if an analyst has any bit of positive language in their rating, it's their indirect way of saying buy the stocks. So if you trust that analyst, buy away. Once the language starts moving even slightly negative you can assume that is as close to a sell call as actually saying it. This range of ratings makes it easier for analysts to be kind of right or wrong and takes some of the pressure off of them from calling the tops and bottoms. In the volatile times, you need to catch the subtle clues.

Low-In-Analysts Stocks
While an analyst covering a company alongside a large crowd may not be the best source for breaking news, especially since those opinions will already be incorporated into the share price, you can potentially benefit from an analyst who covers those unloved stocks or future gems. Here is a list of companies in January 2010 that have few analysts covering them. The major difference in companies like these, beside their much smaller size, is the divergence between the analysts' estimates. An investor can benefit if they pick the right analyst to follow. A common phenomenon in finance occurs when there is a small amount of coverage for a particular sector or stock. These investments tend to outperform the broader activity of the stock market as earnings often will be outside the range of analyst predictions.

Company Sector Market Cap (million) # of analysts covering
Dave Madden Consumer Goods $740.70 5
Schweitzer Mauduit Consumer Goods $1,300 1
SL Industries Technology $55.0 1
YadkinValley Financial Corp. Financial $57.42 5

All of these companies are very different, but they do share limited analyst coverage. This could be for many reasons like lack of institutional ownership, low volume, limited activity in the investment banking area, being out of favor or just too small for anyone to care about them. There are thousands of companies like these just waiting for investors to look into, and the analysts have already started the process for you. All you need to do now is compare and contrast the estimates and decide which one you think will most likely occur based on your personal estimates and analyst track record. If you bet on the right side and the company lives up to the estimate - or perhaps beats it by a large margin - then you may have found an unloved gem.

While companies with limited analysts are a great place to start for finding those next gems, the real treasures are those companies that have yet to be covered by any analysts. Just like those with limited coverage, there are many reasons that no analysts have covered them. The disadvantage of investing in companies yet to be covered by analysts is that you are completely on your own and will have to start from scratch. You have to figure out the best type of earnings model to use, determine the stability of their dividends, etc.

This disadvantage is also the key to finding uncovered gems, especially when markets have had significant corrections. Finding stocks that have not been covered is the best place to find the next hot company, maybe even the next Apple just waiting to be discovered. Some of the best times in the economic cycle to find these gems are turning points where one company is exceeding the others due to some proprietary product or service, or is capitalizing on other companies downfalls by buying up tattered and discounted assets among the ashes of a recession. (Find out what types of stocks perform well in a downturn. Read Industries That Thrive On Recession.)

The Bottom Line
The business of research seems to reinvent itself ever time we see some major market changes, but the basic concept never changes: helping investors understand companies and evaluate the investment worthiness of the company.

Analysts tend to bunch up around companies with large market caps and even those that are not so big but are in the popular crowd. You can pick and choose who to follow from both the buy and sell side, but you are not likely to find any uncovered gems here. Chances are good that all those analysts have scoured through the financials and company guidance. In these cases, herds tend to flock toward the middle and your chances of seeing large earnings surprises are limited. The real gems of the future are found in those stocks that have little coverage or have not been covered at all. (Find out why little companies have the greatest potential for growth. Check out Small Caps Boast Big Advantages.)

Related Articles
  1. Active Trading Fundamentals

    4 Stocks With Bullish Head and Shoulders Patterns for 2016 (PG, ETR)

    Discover analyses of the top four stocks with bullish head and shoulders patterns forming in 2016, and learn the prices at which they should be considered.
  2. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  3. Investing

    Don't Freak Out Over Black Swans; Be Prepared

    Could 2016 be a big year for black swans? Who knows? Here's what black swans are, how they can devastate the unprepared, and how the prepared can emerge unscathed.
  4. Chart Advisor

    Uptrending Stocks Dwindle, a Few Remain (EW, WEC, WR)

    The number of uptrending stocks is shrinking, but here a few that remain in uptrends.
  5. Chart Advisor

    Trade Setups Based on Descending Trend Channels (LBTYK, RRC)

    These descending trend channels have provided reliable sell signals in the past, and are giving the signal again.
  6. Chart Advisor

    How Are You Trading The Breakdown In Growth Stocks? (VOOG, IWF)

    Based on the charts of these two ETFs, bearish traders will start turning their attention to growth stocks.
  7. Stock Analysis

    Analyzing Sirius XM's Return on Equity (ROE) (SIRI)

    Learn more about the Sirius XM's overall 2015 performance, return on equity performance and future predictions for the company's ROE in 2016 and beyond.
  8. Stock Analysis

    Will Virtusa Corporation's Stock Keep Chugging in 2016? (VRTU)

    Read a thorough review and analysis of Virtusa Corporation's stock looking to project how well the stock is likely to perform for investors in 2016.
  9. Stock Analysis

    Analyzing Porter's Five Forces on JPMorgan Chase (JPM)

    Examine the major money-center bank holding firm, JPMorgan Chase & Company, from the perspective of Porter's five forces model for industry analysis.
  10. Stock Analysis

    Analyzing Dish Network's Return on Equity (ROE) (DISH, TWC)

    Analyze Dish Network's return on equity (ROE), understand why it has vacillated so greatly in recent years and learn what factors are influencing it.
RELATED FAQS
  1. When does a growth stock turn into a value opportunity?

    A growth stock turns into a value opportunity when it trades at a reasonable multiple of the company's earnings per share ... Read Full Answer >>
  2. What is Fibonacci retracement, and where do the ratios that are used come from?

    Fibonacci retracement is a very popular tool among technical traders and is based on the key numbers identified by mathematician ... Read Full Answer >>
  3. What items are considered liquid assets?

    A liquid asset is cash on hand or an asset that can be readily converted to cash. An asset that can readily be converted ... Read Full Answer >>
  4. What is securitization?

    Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming ... Read Full Answer >>
  5. What is the formula for calculating EBITDA?

    When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements ... Read Full Answer >>
  6. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
Hot Definitions
  1. Harry Potter Stock Index

    A collection of stocks from companies related to the "Harry Potter" series franchise. Created by StockPickr, this index seeks ...
  2. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  3. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  4. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  5. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
Trading Center