Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific investment advice. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.

Today’s tip: “The best analyst research reports are full of valuable data, but that alone doesn’t mean investors should fall in line with their buy, hold or sell recommendations.”

Virtually every day, some stock drops by 3% to 10% or more, and the only news you can find on it is that a brokerage-firm analyst has changed his recommendation from ‘buy’ to ‘hold’. It’s a natural assumption that the analyst must have a superb long-term record. How else could he be so influential? In the investment business, however, things are rarely so straightforward.

In the first place, most investment research is aimed at portfolio managers. But for most portfolio managers, an analyst’s buy-sell-hold recommendation is the least valuable part of the report. In fact, portfolio managers mostly read brokerage research for the data, rather than the conclusions.

Incidentally, that’s why brokers are willing to give away the change in their analysts’ recommendations as soon as it happens. The value of the reports is in the data, not the recommendations.

Most portfolio managers would agree when I say that I differ with the conclusion on some of the best research reports I read. I appreciate the job the analyst did in gathering and organizing the data, but I interpret the data differently.

I may feel the stock price already reflects the positives and negatives that the analyst uncovered. Or I may have a different view of the influence these factors will have.

However, analysts can have a big impact on the so-called ‘hot money’ crowd, though only in a backward, unintended fashion.

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Stock advice: A slight information edge over the rest of the market

The ‘hot money’ crowd is made up of short-term traders and hedge-fund managers who are constantly looking for even a slight information edge over the rest of the market.

Hot-money managers pay even less attention than conventional portfolio managers to analysts’ conclusions. But they know an analyst’s opinions have much more impact on the sales force than on the clients.

Suppose an analyst issues a highly favourable report on a stock. The firm’s brokers will go out and sell it to their clients, and this can push up the price of the stock.

When the analyst switches his view to ‘hold’, the sales people who respect his opinion will, at the very least, quit recommending the stock to their clients. Some will advise their clients to sell right away. The rest will advise clients to sell the next time they need cash. The hot money crowd quite rightly sees this as a downward influence in the price of the stock, so they sell.

By the time it becomes public knowledge that an analyst has changed his view and the stock has dropped 5%, that downward influence is spent. That alone is a reason why a change in an analyst’s view has no impact on our recommendation.

However, even if I knew ahead of time that some analyst was about to change his recommendation, I wouldn’t necessarily change mine. After all, the best stocks keep going up far beyond most people’s expectations, despite analysts’ temporary misgivings.

COMMENTS PLEASE—Share your investment knowledge and opinions with fellow TSINetwork.ca members

Have the brokerage analysts’ recommendations that are often published in the papers or online ever caused you to make a decision to buy or sell a stock? How did that turn out?

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Note: This article was initially published on August 17, 2012.