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Mutual Funds > Zweig on Funds
Who's recommending your stock?
January 10, 2001

New research dishes dirt on Wall Street analysts. Plus: Tips for daytraders (if you must play that game).
By Jason Zweig
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Are you the sort who stands at attention when your broker calls with news of a recommendation change on a stock? Do you buy or sell based on the information? Or do you imagine Wall Street stock analysts as animals that move in homogeneous herds like sheep and lemmings, a timid bunch with little original thinking to back up their ratings and earnings estimates?

The latter is a sentiment that's gaining in popularity. A story in the New York Times business section on December 31 brought the issue to light, and for several years now, CNBC has used the penguin as the quasi-official mascot of Wall Street, airing images of the lock-stepping birds whenever several analysts rush to cut their ratings only after a company announces bad news.

But that comparison is probably unfair -- at least to the penguins. Yale finance professor Ivo Welch recently looked at nearly 54,000 analyst recommendations from 1989 through 1994. In "Herding Among Security Analysts," published in the December issue of the Journal of Financial Economics, Welch shows that between 13 and 16 percent of earnings estimate revisions are explained simply by the change in estimates of all the other analysts. In other words, instead of spending all their time studying stocks, analysts spend a surprising amount of time studying each other. (You can read Welch's paper at the Journal of Financial Economics' website, or under the Academic Research Papers section of Welch's own site.)

Welch found several other things worth knowing:

•  The bulk of the herding occurs soon after the most recent revision. Within a few days after one analyst adjusts his earnings estimate, the consensus comes closer together as other analysts flock to follow the leader.

•  Analysts are more likely to move in a herd when they're bullish than when they're bearish.

•  The analysts gather in stronger packs when stocks have generated hot returns over the prior 60 days.

So what can you do with all this? You can track analysts' earnings revisions at websites like Zacks, Thomson Invest ( which has estimates from First Call) and Multex. Welch's research suggests that if a stock's price has been on a tear, if most analysts are bullish, and if estimates are rising, then estimates are likely to keep rising. That's good news for the stock price, at least in the short run. (Welch does warn in his paper that the analytical herd is not a particularly good predictor of long-term returns. And it's clear from his work that if you're reading analysts' reports days or weeks after they come out, it's probably too late to profit from them.)

This research helps explain why momentum investing -- buying stocks with rising prices and rising earnings estimates -- can work well in certain markets. (Among cynics, this is also called "the greater fool theory": If you buy, you're a fool, but you can always hope to sell to an even greater fool.)

Personally, I'd never invest this way -- or even dignify it with the name of "investing." But if you want to gamble, it helps to know how the game is played. Actually, reading Welch's paper made me wonder if we should be kinder to lemmings and sheep. Maybe we could better symbolize Wall Street analysts with amoebas, which clump together for safety and rotate like a spinning donut, chasing each other in an endless, mindless dance.






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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.