Understanding the Reliability of Brokerage Recommendations and How to Use Them
Investors often rely on the recommendations of Wall Street analysts when making decisions about buying, selling, or holding stocks. These recommendations, made by sell-side analysts employed by brokerage firms, can have a significant impact on a stock’s price. However, the question remains: do these recommendations really matter?
The Average Brokerage Recommendation for Devon Energy
Before delving into the reliability of brokerage recommendations, let’s take a look at the average brokerage recommendation (ABR) for Devon Energy (DVN). Currently, Devon Energy has an ABR of 1.95, calculated based on the recommendations made by 20 brokerage firms. On a scale of 1 to 5, where 1 represents a Strong Buy and 5 represents a Strong Sell, an ABR of 1.95 approximates between a Strong Buy and a Buy.
The Influence of Brokerage Recommendations
While the ABR suggests buying Devon Energy, it is important to consider the limitations of relying solely on this information. Several studies have shown that brokerage recommendations have limited success in guiding investors towards stocks with the best price increase potential.
The vested interest of brokerage firms in the stocks they cover often leads to a positive bias in the ratings provided by their analysts. Research indicates that for every “Strong Sell” recommendation, brokerage firms assign five “Strong Buy” recommendations. This misalignment of interests can mislead investors more often than guide them.
The Value of Validating Recommendations
Despite the limitations of brokerage recommendations, they can still serve a valuable purpose. One approach is to use them to validate your own research or as an indicator to supplement other successful predictors of stock price movement.
Zacks Rank, a proprietary stock rating tool with a proven track record, categorizes stocks into five groups based on their price performance potential. By using the ABR to validate the Zacks Rank, investors can make more informed and profitable investment decisions.
Understanding the Difference Between ABR and Zacks Rank
It is crucial to differentiate between the ABR and the Zacks Rank, as they are two distinct measures. The ABR is calculated solely based on brokerage recommendations and is displayed with decimals, while the Zacks Rank is a quantitative model based on earnings estimate revisions and is displayed using whole numbers.
Brokerage analysts tend to be overly optimistic in their recommendations due to the vested interests of their employers. On the other hand, the Zacks Rank focuses on earnings estimate revisions, which have shown a strong correlation with near-term stock price movements.
Freshness and Timeliness of Recommendations
Another key difference between the ABR and Zacks Rank is their freshness and timeliness. The ABR may not always be up-to-date, whereas the Zacks Rank incorporates the latest earnings estimate revisions, providing a more timely indication of future price movements.
The Case of Devon Energy
Looking specifically at Devon Energy, the Zacks Consensus Estimate for the current year has seen a 3.2% increase over the past month, reaching $5.97. This growing optimism among analysts, reflected in their agreement to revise EPS estimates higher, could be a legitimate reason for the stock to soar in the near term.
Considering the recent change in the consensus estimate and other factors related to earnings estimates, Devon Energy has been assigned a Zacks Rank #2 (Buy). Therefore, the Buy-equivalent ABR for Devon Energy may serve as a useful guide for investors.
While brokerage recommendations can have an impact on a stock’s price, their reliability is limited. The vested interests of brokerage firms can lead to a positive bias in their analysts’ ratings, often misleading investors. However, by using these recommendations to validate other successful indicators, such as the Zacks Rank, investors can make more informed investment decisions. It is essential to understand the differences between the ABR and the Zacks Rank, as well as the timeliness and freshness of these recommendations. Ultimately, a comprehensive approach that incorporates multiple sources of information and analysis is crucial for successful investing.