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MCF Insights: What Good Are Those Buy, Sell and Hold Ratings?

Interestingly, an investor should have done the opposite in 2018

Investors are constantly bombarded with the terms “Buy”, “Sell”, and “Hold” and the instruction seems simple enough. Often the terms are nuanced with stronger language, so we see “Strong Buy” and “Strong Sell” or the softer “Outperform” and “Underperform.”

But what if we looked backwards to determine whether these recommendations did, in fact, lead to better returns for investors?1 Well, research firm FactSet did just that in 2018. And here is what they found:

A Lot of Buy Ratings, Not Many Sell Ratings

At the start of 2018, there were 11,147 ratings on stocks in the S&P 500.

Of these 11,147 ratings:

  • 49.5% were Buy ratings
  • 45.3% were Hold ratings, and
  • 5.2% were Sell ratings. 

Let’s ignore the obvious question of “why were there only 5.2% of Sell ratings” because that is another topic altogether.

Instead, let’s see how analysts performed in terms of their “Buy” ratings on S&P 500 companies in 2018.

Creating Quintiles to Compare Performance

To analyze the performance, FactSet divided the stocks that were in the S&P 500 into five equal-sized groups of 100 companies (quintiles) based on the percentage of Buy ratings at the start of the year.

  • Quintile 1 – the 100 companies of the S&P 500 with the highest percentage of “Buy” ratings were placed in this group;
  • Quintile 2 – the 100 companies with the next highest percentage of “Buy” ratings were placed in the second group;
  • Same for Quintiles 3 and 4;
  • Quintile 5 – the 100 companies with the lowest percentage of “Buy” ratings were placed in the last group.

FactSet then looked at the average total return and median total return for each group from December 31, 2017 through December 13, 2018 to measure performance. Here are the results:

S&P 500 Companies with Lowest Percent of Buy Ratings Were Top Performers in 2018

Quintile 5 – the 100 companies with the lowest percentage of Buy ratings – recorded the highest average total return (+3.6%) and the highest median total return (+4.3%) of the five quintiles.

In fact, Quintile 5 was the only group to report a positive average total return and positive median total return during this period.

The remaining four quintiles all reported negative average and median totals returns since the start of 2018.

Further, Quintile 1 – the 100 S&P 500 companies with the highest percentage of Buy ratings – recorded the lowest average total return (-3.6%) and the lowest median total return (-6.0%) of the five quintiles.

What Does It Mean?

A cynic would conclude that all these “Buy” ratings are just designed to sell you something. And based on last year’s performance and the fact that there were only 5.2% of “Sell” ratings published, there could be more than a kernel of truth to this conclusion.

But here are some more kernels to think about: that paltry 5.2% of “Sell” ratings are actually the highest percentage since the Great Recession of 2008. And for the past 20 years, analysts have always rated at least 90% of S&P 500 companies as "Buys" or "Holds."

In other words: Big. Fat. Grain. Salt.

1Source: FactSet. All information provided in this article (including the ratings and figures discussed) have been obtained from third party sources and are believed to be accurate, though MCF does not guarantee its accuracy or completeness.

MCF has published this article with permission from Financial Media Exchange.

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