Decoding the Language of Analysts’ Recommendations

Decoding the Language of Analysts RecommendationsWe have had several requests from readers about the work of analysts. Before giving you an insight in this professional work, here’s a look at this jargon.

For example, last week, several analysts have upgraded their recommendation in respect of Alimentation Couche-Tard (Tor., ATD.B). At Scotiabank, Couche-Tard is given the recommendation “Sector Outperform,” meaning that the title, according to the analyst, should do better than its sector. The target price of the analyst over one year is $43, a potential appreciation of 8.3% compared to the price at the time of the report.

National Bank of Canada issues in turn the “Outperform” recommendation with a target of $43, which is identical to that of Scotia. On the BMO side, the recommendation is the same with a target price of $2 more, or $45.

Analysts sometimes have problems with their target price for such securities that perform so well. For example, Raymond James has a recommendation of “Outperform” for Dollarama with a target of $55, which gives a relatively low potential yield given that the stock is trading at $53.81 at the time of publication of the analyst’s report.

If you have a $50 target price on a title in a time horizon of 12 months and it explodes as $54 a few weeks later, you have the choice of doing nothing and letting go beyond your current target, or bring your target near the current stock price, usually at a slightly higher level.

By the way, the target price of the financial analysts is to many people in the know more like the financial decoration. They are of little use when you invest with a horizon of several years. They actually serve to assess the relative optimism of the analyst.

If you want to know more about the definition of the recommendations of the brokerage firm, you should consult the notes relating to disclosure. Each report has at least a couple of pages to the end and is really a flat reading, should you be notified. For example, in case of Raymond James, the recommendation “Outperform” means that the title will do better than the benchmark or the S&P / TSX in Canada and the S&P 500 in the US. Recommendation “Strong Buy” means that the analyst expects a total return of at least 15% within the next six months while outperforming the S&P / TSX.

With BMO, the recommendation “Strong Buy” simply does not exist, while Scotia has a recommendation “Focus stock”, which represents the best idea of the analyst. The same with National Bank of Canada, where the best recommendation is “superior performance” translated into English as “Outperform”.

It is better to have a good idea of the nuances of each firm to better interpret the recommendations. Besides, one would say that the evaluation of an analyst is not in that kind of recommendation. It’s more of his or her analysis of the company, its strengths and weaknesses, as well as its potential. It is this that should get your attention, and differences in the interpretation of analysts related to the same company.

Never forget that analysts are biased. Thus, they are predisposed to recommend or view more positively companies that relate to their firm, for example by funding. It’s a fact of financial life.

Also, beware of false precision: the analyst expects earnings growth of 13.4% for next year is throwing dust in the eyes of investors. It would be more honest to write “between 10 and 15%.”

Finally, look for extremes: the analyst who has a strong buy recommendation or a rare recommendation to sell has a better chance of being right than those insisting on “hold”, which does not mean much. While he or she is not necessarily right, vision and arguments that this recommendation spurs have a great merit of making you reflect on your investment.

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