Investing

This is 'the last place you want to get your stock advice from,' says investing expert

"The market is a weighing mechanism. You have to weigh all the inputs."

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When asked how everyday investors should go about choosing individual stocks to add to their portfolios, financial professionals respond pretty much in unison: Do your own research. But if you have a full-time job that doesn't involve looking at stock charts, analyzing investments can get overwhelming.

"I'm not sure people understand the amount of time consumption and research it takes," says Sam Huszczo, a certified financial planner and founder of SGH Wealth Management in Southfield Michigan. "It takes energy to find a new pick. And then keeping up with everything — the textbook would say you [would ideally] spend an hour per week on each stock." If you own a handful of stocks, that can really add up.

Luckily, there's no shortage of time-saving stock advice on the internet. But when everyone and their mother is touting stocks, who can you trust?

If you're a long-term investor, you'd be wise to ignore daily market headlines, says Sam Stovall, chief investment strategist at CFRA. "The last place you want to get your stock advice from is financial media," he says. "Short-term distribution outlets tell you, 'The world is coming to an end at midnight. Tune in to see if it really did.'"

Media outlets aren't the only ones whose advice it would be wise to take with a grain of salt. From analysts to research firms to newsletter writers, all financial pros have biases and motivations behind their picks — and understanding them will make you a better investor. Read on to find out how.

Analysts are 'optimistic' and more likely to say 'buy' than 'sell'

If you see headlines that a Wall Street firm has called one stock a "buy" or another a "sell," you're seeing ratings from so-called "sell-side" analysts. These analysts each follow a roster of stocks, usually in the same sector or industry, and write regular research reports for the firm's clients. The reports typically feature mathematical models for a company's financial results over the next 12 months, and based on those models, the analyst will assign a rating based on where they think the price will end up.

Analysts want to be seen as providing valuable insights on the stocks they cover, but the job has a marketing element, too. Their research is meant to drum up interest among institutional investors who buy and sell stocks through the investment bank's trading desk.

For this reason, Wall Street analysts tend to issue more buys than sells, says Yung-Yu Ma, chief investment strategist at BMO Wealth Management: "Analysts tend to be an optimistic bunch."

That means they may fail to see market factors that could hurt the sector they cover. "Academic research has shown that analysts tend to do a pretty good job of sorting winners from losers in the industry they cover," Ma says. "But at the macro level, they don't do a very good job figuring out when their whole sector will hit headwinds. Owning the best stock in a sector where everything is down is cold comfort for the investor."

Still, when viewed in aggregate, analysts' estimates for a company's future financial prospects are a great way to assess the valuation of the stock and see where it's headed. Aggregate estimates for the next 12 months can be viewed for free on sites such as Yahoo Finance.

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Independent researchers have 'no ax to grind' but may play it safe

Independent investing research firms offer stock advice and research, generally to paid subscribers. That means they "have no ax to grind," says CFRA's Stovall. "They get paid by making the right calls. There's no corporate finance team. There's no brokerage arm. They don't have an ulterior motive for assigning a 'buy' recommendation to a stock."

Depending on where you do your investing business, you may be able to access their research for free. Open the "research" tab at online brokers such as Charles Schwab, E*Trade, and TD Ameritrade, and you'll likely find reports from the likes of CFRA, Morningstar, and Argus.

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However, these aren't generally the places to go if you want the kind of bold, decisive picks that might make you a lot of money, says Bill Studebaker, president and CIO of ETF firm ROBO Global. That's because analysts are afraid to take a big swing on a stock and get it wrong. "Everyone hugs the consensus number," he says. "Recommendations between firms will only be modestly different."

Rather than making a buy or sell decision based on an analyst's recommendation, it's useful to integrate the research behind that recommendation into your thinking about a particular stock. Morningstar analysis, for instance, includes a "moat" rating for each stock the site covers — a measure of how well a company is equipped to fend off competitors in the same business. Over time, it's been a useful data point for investors. The company's index of "wide moat" stocks — those with the strongest competitive advantages — stumbled in 2020, but has steadily outperformed the broad stock market over the long term.

Some newsletters have a strong track record; others don't

Investigate just about any stock strategy, and you're likely to find a newsletter that covers it. But whether you're investing based on the Dogs of the Dow, companies' buyback announcements, or anything else, treat anyone dispensing stock picks to subscribers with suspicion, says Huszczo.  

"If an investing pro is charging for a stock-picking service, it's a classic sign that their investment fund is underperforming," he says. "If their investments were crushing it, they wouldn't put out a newsletter for pennies when they could make dollars. If they were outperforming, they'd want to keep their competitive advantage a secret."

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Before paying for subscription stock picks, check the long-term track record of the strategy the letter-writer is touting. The Hulbert Finance Digest lists the long-term returns of a few old-school newsletters, such as The Prudent Speculator and The Blue Chip Investor, and the results are mixed. The best strategy returned an annualized 27% over the decade that ended July 31, crushing the 15% return in the S&P. The worst — a portfolio of "speculative stocks" — registered a loss.

Ultimately, it's unwise to put too much stock in any one source of investment advice, says Studebaker. "Everyone has a unique perspective that you should be willing to use. The market is a weighing mechanism. You have to weigh all the inputs," he says. "Over time, you get different perspectives that shape your opinion. It's up to you to be an educated investor and make informed decisions."

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