Many financial advisors, stock brokers and private bankers in Singapore are smart, hard-working people who want to build wealth for their clients. But not all financial advisors are created equal – and some advice is worth ignoring.
There’s a vast industry that’s committed to trying to help you make good stock picks. Every day thousands of stock analysts in Singapore and other financial hubs worldwide scout for suitable stocks they can recommend as “buys”. There’s an even larger number of brokers whose main job is to explain analyst recommendations to clients.
But too many stocks are recommended as a “buy”. Truewealth Publishing set up a screen of 81 stocks listed on the Singapore exchange that are covered by 5 or more analysts. It’s not a surprise that multiple “buy” ratings appeared on this recommendation list. Five of the 81 stocks were rated as “buys” by 100% of the analysts that covered them. And 40 of them were rated a “buy” by over half of the analysts. Analysts seem to be overconfident and over-optimistic.
The following table shows those Singaporean stocks that received the most “buy” ratings. For instance, 8 out of 8 (100%) of analysts covering SIIC Environment Holdings rate the stock a “buy”. Keppel DC REIT is regarded as a buy by 90% of its analysts. And 18 out of 21 CapitaLand analysts feel it’s worth buying.
This doesn’t mean that you should buy all these stocks. So, why are analysts so liberal doling out “buy” ratings?
What stock ratings really mean
First, stock recommendations are code. For most of us, if someone advises us to “hold” something (like a stock, your wife’s purse or a sleeping child), we assume they mean we should not let go of it (or sell it). But in the investment analysis world, “hold” doesn’t mean hold.
As the U.S. securities industry regulator, known as FINRA (Financial Industry Regulatory Authority), has noted, “Clear sell ratings have grown rare… Some firms no longer even use ‘Sell’ or any word obviously like it; frequently, a ‘Hold’ rating in effect means ‘Sell.’”
So, the next time you come across a “hold” recommendation from a broker or in a report, it might be time to consider selling it.
Why analysts say so many stocks are a “buy”
Stock analysts often aren’t looking out for investors. Their main incentive is not to help individual investors but to provide assistance and consultancy services for companies – often the same companies whose stocks they cover. A favourable “buy” rating is a great way to create goodwill with potential corporate customers.
If you think this doesn’t happen, consider what happened during the 1990s tech bubble. New internet companies were being listed on the market every day – and they almost all had strong buy ratings on them (even though most of them didn’t make any money). This inflated the bubble right up until it popped and the whole market came crashing down.
Wall Street, however, made billions in revenue from all the small companies trying to list and advising on large mergers and acquisitions. Brokers also made a lot of money as optimistic analysts rated more and more stocks a “buy” which pushed stock prices higher.
Brokers and advisors prefer “buy” ratings to “sell” ratings. It’s better for their bottom line when clients are excited to buy stocks instead of selling them. Because of this, broker-issued research reports, and “buy” ratings, should always be taken with a grain of salt.
But there is another reason why analysts have a “buy” rating bias – herd mentality. Analysts are, after all, only human and prone to peer pressure. So if an analyst finds that she is (say) the only one recommending Chinese stocks in mid-2016, while all her colleagues are strongly against them, she might question her judgment and change her rating to fit in with the crowd.
Bucking a big trend is intimidating and stressful. There’s no way to tell if an analyst is giving in to pressure or recommending a stock based on pure logic.
One sure sign of herd mentality in markets is when a government starts talking up stock prices. In August 2015, the Chinese government published a statement on People.cn (the government’s media outlet and mouthpiece) saying Chinese investors had nothing to worry about as they were entering a bull market. Of course, they were wrong… and the Chinese market fell 32% over the next four months.
So, the next time you hear an expert on TV or a stock analyst online issue a “buy”’ rating, take it with a big serving of salt… and ask yourself why.