Brokers are often thought to be a bit too optimistic because they rarely ever recommend you sell a stock. That’s why, in my opinion, if the consensus view of brokers is weak for a particular company, there’s little point in investing in it.
That doesn’t mean that all good consensus views will turn out to be winners – but it does mean that the brokers aren’t aware of any problems with the company or its market, and since they keep a close eye on the companies in their watch list, that’s generally a good sign.
You can find out what the brokers are saying on Reuters’ website by typing in a stock code (such as BLY for Boart Longyear, the international drilling company), and then clicking on the ‘analysts’ tab. The table here is what I saw when I typed in one of my stocks – BLY – on the day the market tanked on Thursday last week.
The column headed ‘Current’ contains the latest data and it shows that there were 11 brokers (6+4+1=11) in the survey: 6 said ‘buy’ (1 point), 4 said ‘outperform’ (2 points), 1 said ‘hold’ (3 points) and there were no underperforms or sells. So as you can see from the points system, the lower the mean rating, the better the stock, and vice versa. In this example, the score of 1.55 is a very strong consensus result (6×1 + 4×2 + 1×3 + 0x4 + 0x5 ÷11 = 1.55).
Boart Longyear happened to be the second best rated stock in the Industrials sector that was also in the top 100 on that day. Since the best – TCL – is not in my universe, Boart Longyear (BLY) is my main pick from that sector. It’s a stock I have held for years and I topped up again last week. That didn’t stop BLY falling 9% in the first four hours of last Thursday – and more later! But I didn’t get scared and sell because its rating was so strong.
The broker rating is not an absolute scale for that day; it is a scale relative to other stocks for the medium term – say up to a year ahead. If I had spare cash, I would have bought more BLY on that day, but I had none since I had already done that the week before!
But not all broker recommendations are the same. A similar score of 1.5 could have been achieved with 10 ‘buys’ and 1 ‘sell’. In this case, I would wonder why there was a sell – particularly if it was a recent change because that broker may have some new information.
By looking at the ‘One month ago’ column, I can see that there has been no recent change in the ratings for BLY. But ‘Two months ago ‘, two current ‘buys’ were ‘holds’ – so that is a strong sign that the ratings are improving. ‘Three months ago’ there was one less broker in the survey, but the stock still had a similar rating of 1.6 compared with the current 1.55. That’s all I need to know; I don’t need to follow individual brokers!
With a small universe of stocks – which I have strongly advocated in my columns over the past few months – the task of reviewing these ratings is not arduous. Since I have an automated system (which I pay a lot for!), I check my ratings and various other statistics first thing each day. I only buy a stock for the first time if it has a rating of 2.5 or smaller, and I might top up on a stock provided the rating is better than a three.
When a stock’s recommendation climbs above three, I monitor it closely. I might sell or I might choose to hang on for a while depending on how it fits in my portfolio. These ratings have played a central role in my portfolio construction methodology since I started creating portfolios for clients (and myself!) a few years ago.
Missed a part of Ron Bewley’s portfolio-building series? You can find all his past columns on the Switzer Super Report’s expert page.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
Also in today’s Switzer Super Report
- Charlie Aitken:Â Bottom fishing: what to buy
- Tony Negline:Â How to pass the ‘work test’
- Peter Switzer: Is the RBA missing a world recession?
