Sometimes analyst upgrades/downgrades are useless

By: ispeculatornew
Date posted: 07.15.2010 (4:00 am) | Write a Comment  (4 Comments)

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In the first week of July, China’s Ctrip (CTRP), an online travel business comparable to Expedia (EXPE) in the US dropped big time when online news portal Sina.com reported that several airlines were going to diminish the commissions they were paying which would severely impact Ctrip’s revenues & earnings. The stock crashed and was down 15% within an hour. By day’s end, it had recovered little and had lost nearly 14% of its value. Up until now, the story makes sense.

Then the unthinkable

So the stock had just lost 15% and analysts were finally ready to react. BNP Paribas and Brean Murray were among the analysts that then proceeded to cut the rating on Ctrip. Let me get this straight… Are these downgrades a reaction to the stock falling or are they a prediction of the future movements for Ctrip? The way I understand these ratings, they are supposed to represent the expected movements for the next year. So if Ctrip is downgraded after dropping 15%, is it because it has a lot more to drop in the near future?

Those who listened…

So those who were quick enough to sell actually got the worst selling point possible.

Of course, clients who are digilent got out of their long positions as soon as that happened. However, take a look at what happened in those next few days. That is right, the stock regained a major portion of its losses. Those who did not follow those recommendations had a chance to regain a major portfolio of those losses.

The real question remains…

Did these anyalysts downgrade Ctrip because they did not want a positive rating on a stock that had just tumbled? Or they did downgrade it because conditions changed so much that even a 15% drop still made the stock unatractive? To me, it’s far from clear which it is but it does make a world of difference. I can imagine that an analyst would not want to maintain a “Buy” rating on a stock that just lost much of its value. But if a rating is about the stock’s 1 year perspectives, it should not be influenced by past movements.

A way to resolve this?

Many analysts issue price targets when they update their ratings. That helps a lot because the analyst becomes a lot more accountable. If you have a buy rating on Ctrip with a  50$ price target and you drop the rating to “Hold” after the stocks drops to 32$, you would probably need to give out a $30-35 price target. In that case, the analyst would also need to justify how this one event (commission changes by airlines in this case) has reduced the company’s value by 30-40%. It’s certainly possible that it is the case, but that would certainly make things a lot more clear.

New Criteria

In order to better investigate how well these ratings perform, I will be adding them as a criteria in my stock picks from now on as well as adding the analyst ratings to the IntelligentSpeculator Premium newsletter. Just for your info, the best stock according to these ratings right (from my dashboard) is Quinstreet (QNST) while the worst is Netflix (NFLX). Not too surprised to see Netflix there as I had discussed the possibility of shorting the stock in Sunday’s Premium Newsletter.

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4 Comments

  1. Comment by The Passive Income Earner — July 15, 2010 @ 7:43 am

    It’s interesting because I have been following reports by Scotia Capitla (through ScotiaITrade) and although they attempt at predicting, there is no track record publicly visible. There are many 1 year target that show growth of 20% to 40% and what I would like to know is how accurate many of them are.

    I think you need to find the analyst you like and pay more attention to them and the rest is just noise that you need to filter. I like the StockChase website as it keeps track of what different BNN speaker had to say on companies. You can go back in time and it’s all catalogue.

  2. Comment by The Financial Blogger — July 15, 2010 @ 1:29 pm

    I really would like to see a track record of analysts predictions on stocks, can we find this anywhere?
    I guess not since they are wrong 😉

  3. Comment by John — July 16, 2010 @ 10:35 am

    By curiosity, are analysts really that off?? Like economists could predit that global economic depression be avoided?? Don’t think so!

  4. Comment by IS — July 17, 2010 @ 5:43 pm

    @John – no doubt, the art of making predictions is not an easy one, lots involved including a little luck. And I’m fine with an analyst that misses from times to times. My problem really lies with analysts that change their picks after a major stock gain or loss without enough explaining!

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