Stock Analysts' Poor Record For 2000
April 4, 2002
The elimination of fixed trading commissions in the mid-70s reduced the cost of trading in securities. The resulting trading frenzy by small investors increased demand for stock analysts.
Two related studies show that up to 1999 analysts made good recommendations, but not in 2000.
- Between 1986 and 1996, a portfolio made up of the most recommended stock generated above-market average annual returns of 4 percent, before commissions and other transaction costs.
- In the same period, the least recommended stocks performed on average 9 percent worse than the market.
- In 2000, however, the stock with the most favorable ratings had an annual market-adjusted average return of minus 31 percent; meanwhile, the stock with the worse ratings outperformed the market by 49 percent.
- Investing in the least-favored stocks in 2000 provided a return 80 percent higher than the return from following analysts' recommendations.
One possible explanation for this disappointing performance of financial analysts is the conflict of interest from their increasing involvement in investment banking. Analysts are more reluctant to recommend selling stock, while buy recommendations rose from 65 percent in 1996 to 71 percent in 2000.
Source: "Prophets and Losses," Economic Intuition, Summer 2001; based on Brad M. Barber, Reuven Lehavy, Maureen F. Nichols and Brett Trueman, "Prophets and Losses: Reassessing the Returns to Analysts' Stock Recommendations," Working Paper, and "Can Investors Profit from the Prophets? Security Analysts Recommendations and Stock Returns," Journal of Finance, April 2001.
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