Why listening to a brokerage analyst doesn't make you money

New research by Bloomberg News shows why following advice from stock brokers isn't always the most profitable way to invest.  This research, as highlighted in a recent Investment News article, shows the pitfalls of relying on brokerage analysts recommendations to buy and sell certain stocks.

"Although companies in the S&P 500 that analysts loved the most saw their stocks rise 73%...those with the fewest "buy" recommendations gained 165%, according to data compiled by Bloomberg."

 A few other notable findings from the research:

  • "S&P 500 companies with the most "buy" ratings gained 8.7% last year, while the ones with the fewest jumped 20%, the data show."
  • "Analysts said that health care and technology companies would win last year.  Instead, they had two of the three smallest rallies among 10 industries in the S&P 500, gaining less than 10%.  The stocks that analysts like the least, banks and real estate firms, rose 19% and 28% respectively."
  • "Banks have been among the lowest-rated stocks in the S&P 500 even as their shares gained 172%."

This isn't an anomaly.  This research supports other studies that confirm two important principles of a sound investment strategy:

  1. Picking stocks is a loser's game.  It's nearly impossible to pick which stocks will outperform others.

  2. Value stocks outperform growth stocks in the long run.  Value stocks by definition are those whose share prices are depressed. 

What does all this mean?  Don't rely on brokerage analysts to tell you which stocks to buy or sell.  Instead, choose an investment strategy that focuses on managing risk and getting the best possible return for the appropriate level of risk.