Al Root

Wall Street ratings are a staple for investors, who use upgrades, downgrades, and price targets to identify promising investments -- and help them sleep better at night knowing where their stocks stand with the establishment.

The problem is that Wall Street ratings aren't as helpful as investors believe.

"Sell-side ratings are mostly useless," wrote Trivariate Research founder, and former Morgan Stanley chief U.S. equity strategist Adam Parker in a Friday report. Sell-side refers to analyst firms on Wall Street that "sell" research to the buy-side -- mainly large institutions that manage trillions of dollars.

That's quite a statement from Parker. To justify it, he looked at stock returns for the past 25 years and found that the best returns were concentrated in the least-loved stocks. Still, that doesn't mean investors should pile into the least-loved stocks and wait, he added. It just means that buying up the best-loved stocks on Wall Street isn't a great idea.

One reason investors can't overreact to any one signal or research observation is that things change -- a lot. There are regulatory changes that upend Wall Street, such as Reg FD, or regulation fair disclosure, implemented in the aftermath of the dot.com bubble that stopped companies from selectively disclosing information to analysts and large shareholders. There are also hosts of investors looking for an edge who will arbitrage gains from any new informational signal.

Take upgrades and downgrades. "Incrementally loved stocks," or ones with more and more analysts rating them Buy, beat those falling out of favor with Wall Street between 2001 and 2013, wrote Parker. Following upgrades was a good idea during that period, but the signal "generated no additional return over the last dozen years."

More recently, volatility in analyst price targets has mattered. Stocks with lower dispersion in price targets outperformed those with a wider view of worth. In other words, Wall Street agreeing on what a stock was worth proved helpful for investors looking for a new idea.

For the S&P 500, the difference between the highest and lowest price targets averages about 50% of the current price. Among the S&P 500's trillion-dollar club, Alphabet and Berkshire Hathaway look like good ideas. The dispersion in their price targets is less than 20% of the current stock price. Berkshire, however, only has six analysts covering the stock. The average for the rest of the trillion-dollar stocks is 60 analysts.

Tesla and Nvidia have the worst dispersions of the S&P 500's largest stocks. The difference between high and low target prices compared with the current price is about 150% and 75%, respectively.

Investors, however, shouldn't buy or sell Alphabet, Berkshire, Nvidia, or Tesla based on these tidbits alone, as that signal is fading, too. "The metric peaked in its efficacy in September 2022," added Parker.

It seems as if there is nothing investors can do with ratings. That isn't the case, though. For starters, sometimes knowing what not to do is helpful: Investors shouldn't place too much reliance on them.

Investors can also be a little more intelligent about research and ratings. Analysts are paid to know their industries well, have access to company management teams, and produce financial models, among other things. They aren't necessarily paid to be stockpickers. That's the job of Wall Street's clients.

Knowing what analysts are paid to do helps. They remain a useful source of context for what's going on in a sector or the overall economy, even if Buy ratings don't directly translate into stocks that outperform. Understanding that alone is valuable.

Some other ratings and target-related averages for investors: The average Buy-rating ratio for stocks in the S&P 500 is about 56% currently. The average sell-rating ratio is about 6%. The average analyst price target is about 12% higher than the current stock price. (The average stock price for the S&P 500 is about $225 a share.) About 8% of stocks in the S&P 500 trade above their average target price.

Write to Al Root at allen.root@dowjones.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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February 18, 2025 15:03 ET (20:03 GMT)

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