5 Reasons To Ignore Analysts

University of Georgia professor Paul Irvine published an academic paper in 2002 for the Journal of Corporate Finance. In it, Irvine wanted to know if an analysts' initiation of a stock had any incremental impact on prices. He found that the first initial recommendation affected prices 1.02% more than any future recommendations, positive or negative. The cause being increased liquidity created by the additional analyst coverage. Not surprisingly, a "strong buy" led to greater liquidity and greater incremental returns than any other call. It's a wonder analysts don't initiate coverage with the same rating each and every time. At least then, you'd know they're being transparent. As it stands now, it's hard to tell what they're thinking. Personally, I recommend you avoid them altogether. Here's why. IN PICTURES: 7 Millionaires By Marriage

Lululemon's Lust
Analysts generally seem to like Lululemon's (Nasdaq:LULU) growth prospects. According to Thomson/First Call, out of a sample of nine brokers, its mean recommendation is 2.4 out of five, this despite a trailing P/E of over 40. One analyst in particular has me scratching my head - Erika Maschmeyer of Robert W. Baird. Maschmeyer initiated coverage of the activewear retailer on June 23 with a "neutral" recommendation and then eight days later issued an 'outperform" rating on July 1. Her rationale; the 18% drop in its stock price since the middle of June. However, when Ms. Maschmeyer initiated coverage she issued a target price of $49, the same as on July 1. Why didn't she make her original call with an "outperform" rating? Nothing at the company had changed in those few days.

Price Targets Are Useless
I've never understood the need for analysts to provide price targets. They're arbitrary and subjective, adding almost no insight for investors. I'll give you an example. The Benchmark Company raised Priceline.com's (Nasdaq:PCLN) target price August 4 from $253 to $320. It makes sense given the stock jumped 20% that same day thanks to an extremely positive second quarter report. What would have been insightful is the analyst raising the price target several days or weeks prior to the quarter's release date. Look closely at the 125 companies Benchmark covers and you'll find only four sell recommendations. If their analysis is to be believed, this market is headed to the stratosphere. Price targets should be taken with a grain of salt, as should those who dispense them.

Analysts Aren't Soothsayers
I've talked about upgrades and price targets. Now I'll discuss downgrades. On July 28, Itron (Nasdaq:ITRI), a manufacturer of smart meters beat earnings per share by 25 cents. As a result, Wedbush Morgan reiterated its "outperform" rating and raised its price target by $10 to $85. The weekend came and went, and Itron's rating went with it. Spooked by the apparent loss of the Sempra Energy (NYSE:SRE) contract to Esco Technologies (NYSE:ESE) as well as the potential loss of another to Baltimore Gas & Electric, the broker made an abrupt retreat, downgrading the company to "neutral" and lowering its price target to $62. How is it possible that the potential loss of just two out of the many potential contracts justifies such an outrageous change of opinion? This clearly demonstrates to me that analysts have no better view of the future than you or I - and most certainly less courage of conviction.

Bottom Line
I believe Paul Irvine is on to something. His paper conclusively suggests that analyst research, especially initial recommendations, are meant to juice the markets, thereby producing higher levels of liquidity. Combining his research with the examples above, you are forewarned that taking the word of analyst opinions as gospel is fraught with danger. Do so at your own discretion. (Analyst reports can be an investor's best friend - but without knowing how to read them, you won't be able to fully utilize them. See Analyst Recommendations: Do Sell Ratings Exist?)

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