Investors often look to the recommendations of Wall Street analysts before making a decision to buy, sell or hold a stock. While media reports of rating changes made by these analysts employed (or sell-side) by brokerage firms often affect a stock’s price, do they really matter?
Before we discuss the reliability of brokerage recommendations and how to use them to your advantage, let’s see what these Wall Street heavyweights think. Snowflake Inc. (SNOW).
Snowflake currently has an average brokerage recommendation (ABR) of 1.47, on a scale of 1 to 5 (Strong Buy to Strong Sell), calculated based on actual recommendations (Buy, Hold, Sell, etc.) made by 45 brokerage firms. An ABR of 1.47 is close to a strong buy and a buy.
Of the 45 recommendations that derive from the current ABR, 35 are strong buys and three are buys. Strong Buy and Buy represent 77.8% and 6.7% of all recommendations, respectively.
Broker Rating Distribution Table for SNOW
Check price target and stock forecast for Snowflake here>>>
ABR suggests buying Snowflake, but making an investment decision based solely on this information may not be a good idea. According to several studies, broker recommendations have little or no success in guiding investors in choosing stocks with the greatest potential for price appreciation.
Are you wondering why? Brokerage firms’ vested interest in a stock they cover often results in a strong positive bias from their analysts in their rating. Our research shows that for every “Strong Sell” recommendation, brokerages assign five “Strong Buy” recommendations.
This means that the interests of these institutions are not always aligned with those of retail investors, providing little insight into the direction of a stock’s future price movement. So it would be better to use this information to validate your own analysis or a tool that has proven to be very effective in predicting stock price movements.
Zacks Rank, our proprietary stock rating tool with an impressive, externally audited track record, ranks stocks into five groups, ranging from Zacks Rank #1 (Strong Buy) to Zacks Rank #5 (Strong Sell), and is an effective indicator of where a stock’s price will perform in the near future. Therefore, using ABR to validate the Zacks Rank could be an effective way to make a profitable investment decision.
Although both Zacks Rank and ABR appear on a scale of 1 to 5, they are two completely different metrics.
The ABR is calculated based solely on brokerage recommendations and is generally displayed with decimal places (example: 1.28). In contrast, the Zacks Rank is a quantitative model that allows investors to harness the power of earnings estimate revisions. It is displayed in whole numbers – from 1 to 5.
It has been and continues to be the case that analysts employed by brokerage firms are overly optimistic in their recommendations. Because of the vested interests of their employers, these analysts issue more favorable ratings than their research would allow, thus misleading investors far more often than helping them.
In contrast, the Zacks Rank is driven by earnings estimate revisions. And near-term stock price movements are strongly correlated with trends in earnings estimate revisions, empirical research shows.
Additionally, different Zacks Rank grades are applied proportionately to all stocks for which the brokerage’s analysts provide earnings estimates for the current year. In other words, this tool maintains a balance between the five ranks it assigns at all times.
There is also a key difference between the ABR and the Zacks Rank when it comes to freshness. When you look at the ABR, it may not be up to date. Nonetheless, because brokerage analysts are constantly revising their earnings estimates to reflect changing business trends and their stocks are reflected in the Zacks Rank fairly quickly, it is always timely to predict future stock prices.
In terms of earnings estimate revisions for Snowflake, the Zacks Consensus Estimate for the current year remained unchanged over the past month at $1.17.
Analysts’ strong views regarding the company’s earnings outlook, as indicated by an unchanged consensus estimate, could be a legitimate reason for the stock to move in line with the broader market in the near term.
The magnitude of the recent change in the consensus estimate, along with three other factors related to earnings estimates, have resulted in a Zacks Rank #3 (Hold) for Snowflake. You can see the complete list of today’s Zacks Rank #1 (Strong Buy) stocks here >>>>
So it may be prudent to be a little cautious with the ABR equivalent to purchasing for Snowflake.
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Snowflake Inc. (SNOW): Free Stock Analysis Report
This article was originally published on Zacks Investment Research (zacks.com).
