It may seem like Wall Street analysts’ stock ratings are growing lopsided in favor of the positive, but the portion of stocks rated “sell” isn’t actually a whole lot different from past years, according to a CNBC analysis.
Wall Street researchers are often compensated based in part on their ability to secure investor meetings with corporate management. Some may avoid sell ratings so they can keep those relationships friendly, according to a recent story by the Wall Street Journal. Out of thousands of recommendations tracked by market data provider FactSet for S&P 500 companies, only about 6 percent are sell or “underweight” ratings.
Sell ratings peaked in 2003, around when the stock market had hit bottom after the 2000-2001 crash. The sudden increase was likely caused by new rules enacted by the National Association of Securities Dealers (NASD) in the middle of 2002, requiring that firms disclose their buy, sell and hold percentages.
Brokers were also embarrassed into offering more balanced ratings by the dotcom market crash, Congressional hearings, and high-profile scandals like Enron and WorldCom. From 1997 to 2002, only 1 percent of ratings were sells, and 70 percent were buys. Since then, 5 percent have been sells and 50 percent have been buys.
It’s remarkable that even after sustained public pressure, so few companies are rated sell. Even during the worst of the last two recessions, sell ratings remained a minority of ratings. Since the last market crash, sell ratings have increased slightly and buys have remained largely flat. While it may not be a new thing, the data seem to support the Wall Street Journal’s narrative — brokers may be pressured into high ratings so they can maintain relationships with companies’ upper management.
Not all brokers are equally likely to rate a stock sell. Not only do brokers use slightly different definitions to determine their buy, sell and hold categories, but it’s entirely possible that some firms face more pressure than others to maintain positive ratings.
“Many firms took the easy way out so they don’t offend anyone,” said David Nelson, chief strategist at Belpointe Asset Management. “Morgan Stanley long ago went to ‘Overweight,’ ‘Equal Weight’ and ‘Underweight’ format to avoid calling a stock a sell. ”
Brokers have very different definitions for ratings. Morgan Stanley’s “underweight” category is defined by the analyst’s expectations that the stock’s total return will beat the industry average (risk-adjusted), while Goldman Sachs shoots for a “guideline” that includes 10-15 percent of stocks as sell, 25-35 percent as buy and others as neutral. A UBS sell must have a forecast stock return at least 6 percent below an assumed market return. JPMorgan also uses an overweight/underweight system, while Wells Fargo uses outperform and underperform.
Retail investors may be more likely than professionals to take analyst ratings seriously. And we’re still in a bull market, so many investors will consider a poorly rated stock to simply be a good long-term buy opportunity. But all investors should be careful to take all ratings with a big grain of salt.
“As a portfolio manger and strategist, the rating means little to me,” said Nelson. “Some of my best long are rated sell by the investment community. “
