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Opinion Rating Systems Are Misleading

Even if the Street’s investment opinions were credible, investors still couldn’t determine exactly the meaning of the recommendation. Sometimes Buy means Sell. Brokerage firms have differing stock-rating terminology that can be highly deceptive. Analysts are often forced to hedge, as their investment opinions attempt to straddle dissimilar audiences. Although most firms have contracted their stock opinion format from four or five different gradations to three, there is still excessive wiggle room for hedging. The famous Neutral or Hold monikers are merely a way for analysts to hide and save face, since after the fact they can usually argue that they were accurate, however convoluted the claim. Investors have no clue what to do with such a Hold opinion. Only the highest rating in any firm’s nomenclature, usually Buy, Strong Buy, Overweight, and so on, indicates that the analyst has a favorable view on a stock. Or does it?

In the latter part of 2006, according to Barron’s, a Morgan Stanley analyst initiated coverage of Toll Brothers with an Overweight rating, the stock trading above $29. Sounds positive, doesn’t it? Well, the price target was $23, indicating his expectation of a major drop in price. Apparently, that firm’s rating meant only that the stock would do better than its counterparts in the home building industry. This is no help to investors who might have believed the opinion called for a bigger position than the norm, and who could lose that much more money. Confusion reigns.

Analysts use lower-level ratings, such as Accumulate, Above Average, Hold, Neutral, and sometimes even Buy (if the firm has a superior Strong Buy in its system), to convey a negative stance to their key client base, institutional investors. They avoid the more pessimistic classification levels like Below Average, Underweight, Under Perform, or Sell. In order to dodge the flack from corporate executives and those institutional investors who own big positions in the stock. It is also a way to massage investment bankers. Accumulate opinions were once referred to euphemistically as a Banker’s Buy. Sounds positive, but in reality it’s negative. It helps the analyst save face.

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