Investors often turn to Wall Street analysts for guidance when deciding whether to buy, sell, or hold a stock. Media reports about these analysts changing their ratings can significantly impact a stock’s price. But how reliable are these recommendations? Before we dive into the usefulness of brokerage recommendations, let’s see what Wall Street analysts think about ServiceNow (NOW).
ServiceNow currently holds an average brokerage recommendation (ABR) of 1.29, on a scale of 1 to 5 (Strong Buy to Strong Sell), based on the recommendations from 34 brokerage firms. An ABR of 1.29 suggests a rating between Strong Buy and Buy. Of the 34 recommendations, 29 are Strong Buy and two are Buy, making up 85.3% and 5.9% of the total, respectively.
While the ABR indicates a strong Buy for ServiceNow, relying solely on this information for investment decisions might not be wise. Numerous studies have shown that brokerage recommendations have limited to no success in guiding investors toward stocks with the highest potential for price appreciation. Why? Brokerage firms have a vested interest in the stocks they cover, often leading to a strong positive bias in their analysts’ ratings. Our research reveals that for every “Strong Sell” recommendation, brokerage firms assign five “Strong Buy” recommendations. This reveals that the interests of these institutions don’t always align with those of retail investors, making their recommendations less than helpful in predicting future stock price movements.
Therefore, it’s best to use the ABR as a tool for validating your own analysis or using a system proven to be highly effective in predicting stock price movements. The Zacks Rank, our proprietary stock rating tool with a robust externally audited track record, categorizes stocks into five groups, ranging from Zacks Rank #1 (Strong Buy) to Zacks Rank #5 (Strong Sell). This tool effectively indicates a stock’s near-future price performance. Using the ABR to confirm the Zacks Rank can be an efficient way to make profitable investment decisions.
It’s crucial to understand that ABR and Zacks Rank are distinct measures. The ABR is based solely on brokerage recommendations and is typically displayed with decimals (e.g., 1.28). In contrast, the Zacks Rank is a quantitative model that utilizes the power of earnings estimate revisions. It is displayed in whole numbers (1 to 5).
Analysts employed by brokerage firms have consistently been overly optimistic in their recommendations. Their ratings are often more favorable than their research supports, due to the vested interests of their employers. This misleads investors more often than it guides them. Conversely, the Zacks Rank is centered on earnings estimate revisions. Empirical research shows a strong correlation between earnings estimate revision trends and near-term stock price movements. Additionally, the Zacks Rank is applied proportionately across all stocks for which brokerage analysts provide earnings estimates for the current year. This ensures a balance across the five ranks it assigns.
Another key difference between ABR and Zacks Rank lies in their timeliness. The ABR is not always up-to-date. However, as brokerage analysts revise their earnings estimates to reflect a company’s changing business trends, these changes are quickly reflected in the Zacks Rank, making it a reliable indicator of future price movements.
Regarding ServiceNow, the Zacks Consensus Estimate for the current year has remained unchanged at $13.75 over the past month. Analysts’ steady outlook on the company’s earnings prospects, as reflected in the unchanged consensus estimate, could be a valid reason for the stock to perform in line with the broader market in the near term. This, along with three other earnings estimate-related factors, has resulted in a Zacks Rank #3 (Hold) for ServiceNow. Therefore, it might be prudent to be cautious about the Buy-equivalent ABR for ServiceNow.
