Stock Trading: Are "Strong Buys" Worth "Strong Buying"?

Analysts don't work for you. Their job is NOT to make you money; it is to keep their masters happy by making their biggest clients - corporations and institutional money managers - happy.

Corporations come to Wall Street for one purpose only: to raise money. That is, to take it from you and blow it on the next big project or acquisition. How does Wall Street make you buy a stock? That's right, by recommending it.

When a money manager wants to buy a stock for his mutual fund, he wants to pay the lowest price. How does he get it? By discouraging demand. This can be done in a variety of ways: downgrading the stock or simply withholding an opinion when one is expected. If, on the other hand, an institution wants to sell a stock, it needs to generate demand, and the best way to do that is by having an analyst recommend the stock.

Institutions are not infallible, they make plenty of mistakes. And while a fund manager does not have a problem losing millions of dollars of his clients' money, his primary goal is to not lose his job. How does he do that? By having rock-solid justifications for his actions, like only buying stocks that are rated Strong Buy by a number of prominent analysts, no matter how ridiculous those recommendations may be. I think we have a term for that in everyday life. That may explain why so many falling stocks remain Buys all the way into bankruptcy.

Another interesting thing is that Wall Street always has more Buys than Sells. That's a mathematical impossibility: every transaction must have a buyer and a seller. So if an analyst says "Buy," the question is: from whom? Who is selling, and why, if supposedly the most knowledgeable person is saying: buy? And if most recommendations are Buys, when are we supposed to sell? Or should we just keep buying and holding forever?

Most analysts go to the same schools, read the same publications, and use the same valuation models. They talk to each other more than they talk to the companies they cover. They think alike. And most consider themselves so bright that they believe they know better what a stock should do. It blows my mind when, for example, reports of record snow in January are followed by reports of a "surprise" drop in home sales in January. Hello? Do they look out the window? Who is going to go house hunting in a blizzard?

Many analysts' recommendations boil down to rating past stock performance. A stock is up - upgrade. A stock is down - downgrade. A fourth grader can do that.

Stock analysts are paid a lot of money. If their opinions are so valuable, why are so many of their reports free? Where do the masters get the money to pay them the big bucks? Perhaps, just perhaps, they make them off of you by making you buy and sell when it suits them?

The bottom line: most analyst stock recommendations are useless. You will never know what's behind one: investment banking business, a mutual fund selling, or an analyst's pride of opinion. And you will NEVER get rich following analysts' recommendations.

It's true: rating changes often move a stock, but these moves are usually unsustainable, lasting on average no more than three days. So the best way to play stock recommendations is to trade in the direction of the change but not overstay the welcome.