Stock analyst ratings are still excellent contrary indicators, according to a recent Bloomberg study:
Companies in the Standard & Poor’s 500 Index that analysts loved the most rose 73 percent on average since the benchmark for U.S. equity started to recover in March 2009, while those with the fewest “buy” recommendations gained 165 percent, according to data compiled by Bloomberg. Now, banks’ favorites include retailers and restaurant chains, the industry that did best in last year’s rally and that are more expensive than the S&P 500 compared with their estimated 2011 profits.
Investors who look at the analysts as a contrary indicator are buying shares of utilities, which pay the highest dividends after telephone stocks, and banks, whose earnings are likely to grow three times as fast as the S&P 500 this year. Don Wordell, a fund manager at Atlanta-based RidgeWorth Capital Management Inc., says equities that Wall Street firms rate lowest are more likely to beat the market.
Great investments and trades are often widely hated – when there’s nobody left to sell something, that means it’s probably about time for it to bottom out.
We see the same thing with analyst ratings – aside from this most recent study, we’ve seen this phenomenon cited over and over again. Wall Street darlings often crash hard, because they have a great deal of good news already baked into their lofty valuations.
Investing legend Martin Zweig alluded to this a bit in his book Winning on Wall Street, as he mentions a strong aversion to richly priced stocks. He considered a P/E of 20 rich, and generally avoided stocks trading at valuations above this.
I might append the bullish analyst ratings as an overlapping group of stocks to avoid. Maybe you have to sit on your hands a lot of the time as a result, but at least that’ll keep you out of trouble!