Investors often rely on recommendations from Wall Street analysts when deciding whether to buy, sell, or hold a stock. While media reports about rating changes from these brokerage-firm analysts often impact a stock’s price, do these recommendations truly hold weight? Let’s examine the case of ASML (ASML) and explore the reliability of brokerage recommendations.
ASML currently has an average brokerage recommendation (ABR) of 1.40, on a scale of 1 to 5 (Strong Buy to Strong Sell). This ABR, calculated based on recommendations from 20 brokerage firms, suggests a strong buy or buy rating. However, solely relying on this ABR to make an investment decision might not be prudent. Numerous studies have indicated that brokerage recommendations have limited success in guiding investors toward stocks with the most potential for price appreciation.
The reason for this lack of effectiveness lies in the vested interests of brokerage firms. Analysts often exhibit a strong positive bias in their ratings due to their firm’s stake in the stocks they cover. Our research reveals that for every “Strong Sell” recommendation, brokerage firms issue five “Strong Buy” recommendations. This demonstrates that their interests may not align with retail investors, and their ratings might not accurately reflect a stock’s true price trajectory.
Instead of solely relying on ABR, a more effective strategy would be to use it as a validation tool for your own research or consider using a proven indicator for predicting stock price movements. The Zacks Rank, a proprietary stock rating tool with a strong track record, categorizes stocks into five groups, ranging from Zacks Rank #1 (Strong Buy) to Zacks Rank #5 (Strong Sell). This tool has consistently proven effective in indicating a stock’s near-term price performance.
It’s important to distinguish between the ABR and the Zacks Rank. While both are on a scale of 1 to 5, they are distinct measures. The ABR is based solely on brokerage recommendations, typically represented in decimals (e.g., 1.28). Conversely, the Zacks Rank is a quantitative model that utilizes earnings estimate revisions, represented in whole numbers (1 to 5).
Historically, brokerage analysts have been overly optimistic with their recommendations due to their employers’ interests. They issue more favorable ratings than their research might support, often misguiding investors. The Zacks Rank, in contrast, relies on earnings estimate revisions, which empirical research has shown to be strongly correlated with near-term stock price movements. Additionally, the different Zacks Rank grades are applied proportionately to all stocks with current-year earnings estimates, ensuring a balanced distribution across its five ranks.
Another key distinction is the timeliness of the ABR and Zacks Rank. The ABR may not always be up-to-date. However, since brokerage analysts continually revise their earnings estimates to reflect changing business trends, the Zacks Rank quickly reflects these changes, providing a timely indication of future price movements.
Regarding ASML, the Zacks Consensus Estimate for the current year has remained unchanged at $20.30 over the past month. This steady view of the company’s earnings prospects, indicated by the unchanged consensus estimate, suggests that the stock may perform in line with the broader market in the near term. The recent changes in the consensus estimate, along with other earnings estimate-related factors, have resulted in a Zacks Rank #3 (Hold) for ASML. Therefore, while the ABR suggests a buy rating, it might be prudent to exercise caution due to the Hold rating from the Zacks Rank.
