Stocks just had their worst December since the Great Depression and Wall Street analysts are scrambling to update their price targets and recommendations.
Analysts tracked by Factset Earnings now see fourth quarter earnings for the S&P 500 just 12.4% higher from 2017. That’s from estimated growth of 16.6% in late-September and profits are expected just 7.9% higher for 2019 versus last year.
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The end-of-year recommendations and estimates have become a deafening roar as analysts sell investors into the next hot stock.
Analysts aren’t infallible and are sometimes just plain wrong. In fact, playing the contrarian against analyst recommendations could help you find opportunities ready for the rebound.
Should You Follow Analyst Recommendations In Stocks?
Analyst stock ratings can seem like a crap shoot with research by NerdWallet showing that Wall Street professionals are only right just over half (51%) of the time. Analyst ratings are also skewed highly positive with less than 5% of ratings on Dow 30 stocks given as a sell recommendation versus more than two-thirds ratings given a buy or strong buy.
Wall Street analysts are notorious for going bullish on shares at a top. One of 2018’s top picks, Owens Corning (NYSE: OC), was rated a strong buy going into the year with four buy-ratings and only one hold. The shares have since tumbled 55%, underperforming the S&P 500 by more than 40% on the year.
It seems analysts are no better at calling a top in stocks either. Scana Corporation (NYSE: SCG) was in the top five most-hated stocks as of May with a third of analysts rating the shares a sell. Just 11% of analysts had a buy on Scana with another 56% rating the company a hold. Shares have surged 28% in the last eight months of the year, easily outperforming the broader market.
But there are reasons to follow analyst recommendations that can help find opportunities. In the same research cited above, analysts did even worse on Hold and Sell recommendations with far less than half of the stock picks performing in-line or worse than the general market.
If analysts are only so-so at calling out the winners, they’re even less adept at pointing out losers.
Analyst downgrades often lead to a selloff in shares and a shakeout of short-term investors. That can mean selling pressure subsides and support for the shares as only long-term investors and funds are left investing.
Multiple downgrades of a stock can also lead to a bottoming in sentiment and set the shares up for a surprise rebound around any positive headlines or earnings release.
Three Stocks That Could Defy Analyst Downgrades
Playing the contrarian against analyst downgrades isn’t enough in itself but looking for recent negative actions can sometimes uncover shares with stronger fundamental value than Wall Street is crediting.
Looking for these opportunities, make sure you do your own research and be careful not to drown out analyst research that doesn’t confirm to a pre-existing opinion on a stock. Use your own research as well as analyst coverage impartially to find where shares have fallen too far. Watch for companies with solid brands and the financial flexibility to survive short-term negative trends in sentiment.
Ctrip International (NYSE: CTRP) is the largest online travel agency in China in an industry that is still only a third the size of that in the United States. Revenue has surged at an annualized rate of 45% over the last five years with net income jumping 25% annually.
Despite this growth, shares have plunged 46% since June on fears of a slowdown in China and the escalating trade war.
Analysts have piled on against the company with six downgrades since the beginning of November. Most actions were to a neutral or hold position though the most recent recommendation, by Daiwa Capital on Nov. 9, cut the stock two ratings from Buy to Underperform.
Even on a slowdown in China growth, the economy is still growing at 6% plus a year, and the trade war seems to have de-escalated for now. The long-term outlook for travel in Asia is extremely strong and management is guiding to an operating margin of 30% over the next few years against 18% currently, as it develops for more pricing leverage.
Shares trade for 20 times earnings though earnings-per-share are expected lower by 33% over the next four quarters. Ctrip has beaten analyst expectations every quarter of the last 12 with an average surprise of 80% in the last six quarters.
Waters Corporation (NYSE: WAT) is a leader in the liquid chromatography market, which accounts for 90% of revenue, but also provides instruments in the pharmaceutical, biochemical and industrial markets. Shares have been under pressure last year as a trough in the product cycle slows revenue growth though 2019 is expected to bring a refresh in the cycle.
The company has faced a slew of downgrades over the last three months with ratings cuts from JP Morgan, Goldman Sachs and Janney Capital. Just one analyst of 11 rates the shares a buy while three analysts have come out with sell recommendations.
The most recent sell recommendation, from JP Morgan, hit the shares on Dec. 12. The freefall of 17% since the beginning of the year means the downgrade had less effect on the price with much of the bad news already priced into the stock.
Shares trade for 22.7 times earnings with EPS expected to increase 10.5% over the next four quarters. The company has beaten analyst expectations in 11 of the last 12 quarters with an average surprise of 3.7% over estimates.
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Ford Motor Company (NYSE: F) has stumbled along with the rest of the auto market over the last several years, losing 43% of its market cap in 2018. A slowdown in annual sales has been partially offset by higher pricing though revenue has only grown at a 3.3% annualized pace over the last five years.
Ford has received one upgrade and one downgrade since October with Morgan Stanley cutting the shares to equal-weight even though it holds a $10 price target on the stock. Of the 13 analysts tracked, the shares have one sell rating and nine holds.
Analysts have grown progressively more bearish on the Auto & Auto Parts industry in general. One year ago, six analysts had buy-recommendations on shares in the industry with 13 hold-ratings and three sell-ratings. Just one analyst now has a buy recommendation and 10 analysts have stopped providing ratings, usually as an alternative to providing a negative recommendation.
Ford has gone through a major restructuring over the last few years, focusing more on North America and China. The company has reduced its common platforms on which it builds vehicles from 27 in 2017 to just nine currently. The move has improved profitability and the many of the remaining brands, most notably Lincoln in China and India, are seeing stronger sales.
While weakness throughout the auto industry could take a few more quarters to turn, shares of Ford trade for just 5.5 times trailing earnings. Earnings per share are expected 3.6% higher over the next four quarters and the company has beaten expectations in seven of the last 11 quarters, surprising by an average of 22% over the period.
Risks To Consider: Analysts are generally bullish on stocks and slow to downgrade so make sure you look closely and impartially at their case for going negative on a company.
Action To Take: Look for contrarian investments in stocks with recent or multiple analyst downgrades to take advantage of a bottom in the shares.