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Recent articles by Harry Domash: • 3 keys to by-the-numbers stock-picking, 8/15/2004 • Invest like a young Warren Buffett, 8/1/2004 • How to invest like Peter Lynch, 7/18/2004 More... |
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What analysts say about when to buy and sell stock matters a lot in the market's expectations game. Use this Sentiment Index to read those ratings. By Harry Domash By now, we know all too much about stock analysts' shortcomings. But even though you can lose your shirt following their advice, you should still pay attention to their buy/sell signals. Here's why. The stock market is all about expectations. Stocks move up when they exceed expectations and fall when they don't. In the market, just like in love, high expectations frequently lead to disappointment, but low expectations are often exceeded. You'll be a better investor if you take the market's expectations into account when you analyze a stock. But what you do with the information depends on your investing strategy. Value = rock-bottom expectations For instance, say you're a value investor who seeks out beaten-down stocks that will likely recover. In my view, the biggest challenge for value investors is figuring out whether a stock is really a value candidate. Picking stocks because they have low P/Es or other valuation ratios hasn't worked for me.
What does work is finding stocks that the market hates . . . stocks that most investors wouldn't consider. These are low-expectation stocks. The bar is so low that, if they survive, they're bound to eventually surprise on the upside. Growth needs buzz By contrast, growth investors need stocks with positive 'buzz.' In the end, stocks move up because demand exceeds supply. Many investors, especially institutions, learn about stocks from analysts. Assuming the analysts are advising buying, the more analysts, the greater the demand. Stocks fitting this description are high-expectation stocks. How do know whether your stock has high or low expectations? I've devised a Sentiment Index based on analysts' ratings. I find it a useful tool for gauging the market's expectations for a stock.
The Sentiment Index scores analysts' ratings based on my interpretation of what analysts probably mean, not what they say. For instance, in my experience, "strong buy" is the only rating most analysts apply when they mean "buy." The lower "buy" rating really means "hold" while the analyst waits for further developments before deciding whether to advise buying or selling. All "hold," "sell" and "strong sell" ratings translate to "sell." The difference between one analyst's "hold" and another's "sell" probably has more to do with political or legal considerations than the analysts' opinion of the stock. You can see a summary of the analysts' buy/sell ratings on MSN Money by selecting Analyst Ratings from the Research menu after getting a price quote on a stock. Here's how to calculate the Sentiment Index: Sentiment Index Calculation 1) Add the number of "strong buy" ratings. 2) Ignore all "buy" ratings. 3) Subtract a point for each "hold," "sell" or "strong sell" rating. Here are some examples:
Interpreting the sentiment index High negative scores (-4 or below): These scores reflect strong negative sentiment; thus, these stocks make the best value candidates. Scores can easily drop into the negative teens and some into the minus 20s. For instance, the last time I looked, Lucent Technologies Low scores (-2 to 2): These scores tell you that sentiment isn't strong in either direction. I've found good growth prospects in this range, but it doesn't work the other way. I've never had success picking value stocks with sentiment scores this high. Restaurant operator Buffalo Wild Wings Mid-positive scores (2 to 4): You won't find "undiscovered" stocks in this category, but they aren't overhyped either. Last week, fast growers such as software outsourcer Cognizant Technology High-positive scores (6+): These "in the limelight" stocks are covered by analysts in droves, and most advise buying. Currently, you'll find the likes of Halliburton Historically, the highest sentiment score I've ever tabulated, a 17, was racked up by telecom equipment maker ADC Telecommunications The Sentiment Index could be a useful addition to your analysis toolbox. But it's not meant to be used alone. For instance, don't decide that a stock is a good value play simply because it has a high negative score. You still have to do your due diligence. Harry Domash does not own or control positions, either long or short, in any of the stocks mentioned in this article. | |||||||||||||||
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MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.