Why reading analysts’ reports can be worth your time

Sadly, most investors fixate on the wrong thing when reading analyst reports. Investors often look at the top of an analyst report for the stock rating and see if the stock is deemed buy, hold, or sell. The simplicity of those ratings makes them irresistible, and investors may feel tempted to follow them. Unfortunately, many investors get themselves into trouble and risk losing a large sum of money when they blindly follow the ratings they read in analyst reports.

The stock ratings from analysts are infamously hit or miss. During 2022, for instance, nearly 80 percent of the stocks with average buy or outperform ratings in January fell during the first nine months of the year, according to data from S&P Global Market Intelligence. Granted, that’s too short a period to evaluate analysts’ stock-picking skill. But it means even if you buy a stock recommended by an analyst, don’t expect it to pay off right away.

Despite their problems, though, analyst research reports can contain some solid information. Some of the reasons why you might want to take a look at analyst reports include:

• A way to double-check your own analysis: Most of the analysts who write these reports are highly trained financial professionals who know how to do everything from discounted cash flow, or DCF, analysis (as covered in Chapter 11) to advanced valuation measurement. You might want to compare the results of your DCF model with those created by professional analysts to see if they’re in the same ballpark.
• Industry insight: Many times the analysts assigned to cover an industry either have studied that field for a long time or even worked at a company in the business. This in-depth industry experience can help you improve your analysis of a certain type of business.
• Dissenting point of view: If you’re convinced a stock is a screaming buy, it might make sense to seek out analyst reports that are less bullish on that stock. Perhaps the bearish analyst will point out things you didn’t notice in your own analysis.

Analysts’ reports are infamously overly bullish. For a variety of reasons, research reports from Wall Street brokerage firms tend to rarely slap a dreaded sell rating on a stock. The fact so few companies get a sell rating underscores why you need to remember that when a Wall Street firm rates a stock a hold, that’s actually a fairly negative recommendation you might consider to be a sell.

Understanding the types of firms that put out stock research

Not all analyst research reports are created equal. While the term analyst report is a catchall used to describe nearly all investment research generated by professional analysts, there are many flavors of research to be aware of.

The first way you should differentiate research in your mind is based on the source. Knowing where research is coming from, and how the person or firm generating the report gets paid, is vital to understanding what the potential biases and shortfalls in the research might be. Typically, research reports are put into one of two categories based on their source, including:

Keying into the main types of analyst research

Just as there are many types of books, there are many types of analyst research reports. As a fundamental analyst, there are two main types of reports you need to concern yourself primarily with, including:

• Idea reports:Idea reports are usually lengthy pieces of research an analyst publishes to lay out everything investors need to know about the company, industry, and the stock. These reports are often released when an analyst initiates coverage of a stock, or begins to regularly follow a company. Some analysts often publish idea reports every year, where they take a comprehensive look at the just-completed year for the company and forecast what might happen next year. These idea reports are usually chock-full of industry statistics, which might come in handy when you dig into how to do industry analysis in Chapter 16.

  Idea reports can be excellent ways for fundamental analysts to get up to speed on a company or industry they hadn’t been aware of before.

• Maintenance reports: If idea reports are long and comprehensive, maintenance reports are just the opposite. Analysts usually dash out quick maintenance reports following major events at a company, such as the release of earnings or the announcement of a significant new product.

  Maintenance reports are kind of like an episode of a soap opera: Unless you’ve been following along (and reading earlier reports) you might not be able to follow what’s going on in a just-released maintenance report. It can be a good idea to review an analyst’s idea report on a company along with the maintenance report.

How to read between the lines of an analyst report

After you determine whether or not a research report is an idea or maintenance report, it’s time to start reading more closely. Because I urged you to be skeptical of the stock rating on most research reports, you might be wondering what you’re supposed to pay attention to instead in the report.

Some of the key pieces of data you should be on the lookout for in an analyst report include:

• Savvy comparisons of a company to its peers: Analysts most frequently will be assigned to cover an entire industry, including both the large stalwarts in the business and the small up-and-comers. Sometimes analysts are able to pinpoint a company’s strengths and weaknesses that aren’t readily apparent from studying the financial statements.
• Deep analysis of demand for a company’s products: The better analysts perform what are called channel checks. In a channel check, an analyst will call up a company’s customers and suppliers to see how well a particular product is flowing through the distribution channel. Analysts might find out, for instance, that retailers are slashing prices on a company’s products just to clear them off the shelves. That’s not a good sign. On the contrary, a supplier might say a company is ordering a great deal of raw materials, which could indicate the company is ramping up production.
• Forecast for long-term growth: One of the most difficult aspects of fundamental analysis is getting a realistic expectation for the future. I give you some pointers on how to estimate a company’s expected growth rate for the next five years in Chapter 11. But it’s not a bad idea to check analyst research reports to see what five-year growth forecasts they have.

• Exploration of a stock’s valuation: Understanding how to measure whether a stock is cheap or expensive is one of the top things investors try to do. There are many ways to attempt measuring a stock’s valuation, including looking at price-to-earnings ratios (Chapter 8) and performing the discounted cash flow analysis (Chapter 11). Both of these analyses, though, are subject to numerous assumptions and educated guesswork.

  Sometimes it can be helpful for you, then, to examine the valuation assumptions and results determined by professional analysts. Even if the results don’t agree with your findings, you can compare what they measured to what you measured, see why there’s a difference and adjust your model if needed.

If you’re looking for help with the discounted cash flow model, stock reports from CFRA can be useful. A vast majority of the stock reports from CFRA, which can be obtained using the directions I provide in the “Getting your hands on analyst reports” section in this chapter, can help you calculate the stock’s discount rate and terminal growth rate. The discount rate is the rate of return investors demand in exchange for putting their money at risk by giving it to the company. The terminal growth rate is how much the company’s earnings and cash flow are expected to grow in the very long term. Both the discount rate and terminal growth rate can have a major effect on the results of the DCF analysis.

Analyst research reports can be very helpful when their insights help you tweak your own fundamental analysis for the better. But, there’s an ugly underside to analyst reports, too, especially when the authors are cheerleading or touting a stock. It can be difficult, until it’s too late, to know when an analyst report is being more promotional than insightful. A few things to watch out for, though, include reports that attempt to say recent bad news isn’t that terrible, without justification. Also, be suspect of analyst reports that try to say a company is so well-managed or well-positioned that it’s not subject to the ups and downs of the economy. As you’ll discover in Chapter 15, all companies are subject to the typical ebb and tide of the broad economy.

Getting your hands on analyst reports

By now you’re probably tired of reading about analyst reports and ready to get your hands on some. Accessing analyst reports is easy, and may even be free depending on which brokerage firm you use. There are four primary ways to get analyst reports, including:

• Your brokerage firm: If you’re a client of the big Wall Street firms, one of the perks you receive is access to the firm’s analysts’ reports. You might be able to access the reports yourself, or you may be able to ask your individual broker for a copy.

  What if you’re with a low-cost online discount broker? You’re still in luck. A vast majority of the online brokerage firms provide you with research from both the Wall Street firms and from independent research firms. Charles Schwab, for instance, provides access to CFRA research reports, as well as access to its own quantitative research model called Schwab Equity Ratings. TD Ameritrade also provides access to CFRA reports at no charge.

• Directly from research providers: Most boutique research firms and even the larger independent research providers will sell their research to you. New Constructs (www.newconstructs.com), which uses fundamental analysis to rate stocks, offers access to its reports starting at $49 a month.
• Analyst research summary websites. Several websites let you look at the high-level summaries of analyst reports. Most of these sites give you the average recommendation of all the investors who follow a stock, which may be more valuable than just the opinion of one analyst. For instance, MSN Money (https://www.msn.com/en-us/money), lets you look up the breakdown in stock ratings for individual stocks. Enter the company’s name or symbol in the Search Quotes blank. Click the name of the company when it appears and then click the Summary tab. You’ll see a breakdown of analyst estimates on the right side of the screen.

The role of reports issued by credit-rating agencies

If you’ve ever compared a credit-rating agency’s report with a stock analyst report, even for the same company, you might be surprised at how different they are. Both the credit and stock reports will take a look at popular financial ratios, such as the debt-to-equity ratio and various interest coverage ratios, discussed in Chapter 8.

But while stock analyst research reports try to help investors make money, the credit-rating agencies reports are primarily concerned with helping investors just get their money back, with interest.

Bond investors are very different from stock investors. They are lending money to a company, and get no piece of the upside if the company does better than expected. Bond investors simply want to get their money back from the company that borrowed from them. For that reason, credit analysts look at companies very differently than stock analysts do. For instance, credit analysts have very little interest in a company’s stock valuation. Bond investors don’t care if a stock is overvalued, as long as the company can afford its interest payments and they get their money back.

But while the credit-rating companies are serving bond holders, not the stock holders, fundamental analysts interested in a company’s stock can benefit from the reports. Some of the aspects of credit-rating agencies’ reports that might be especially valuable include:

• The credit rating: The credit-rating agencies assign various letter grades to companies. These letter grades attempt to give investors a quick way to determine how likely it is for a company to repay its debt, or, on the contrary, to default or miss an interest payment. These ratings also determine how much companies must pay in order to borrow. The credit rating can determine a company’s borrowing costs — which in turn can directly affect its profitability. Table 14-1 summarizes the credit ratings from both Moody’s and S&P, and what they mean.

  Just as you should never take too much stock in a stock analyst’s rating, you should also exercise discretion when looking at a company’s credit rating. Because the credit-rating agencies are paid by the companies to provide their ratings, there’s long been suspicion that credit ratings give companies a great deal of leeway. The analysis behind the rating, instead of just the rating itself, has the most value for fundamental analysts.

• Analysis of how much and how often the company is borrowing: The credit-rating agencies take interest, and sometimes concern, when a company borrows more money by selling additional bonds. New bond issuances are monitored and explored in most credit-rating agencies’ reports.

  Quality of Debt	Moody’s	S&P
  Best	Aaa	AAA
  High	Aa	AA
  Upper-medium	A	A
  Medium	Baa	BBB
  Lower-medium	Ba	BB
  Low	B	B
  Poor	Caa	CCC
  Highly speculative	Ca	CC
  Extremely poor	C	C
  In default	C	D

• Risk assessment: While companies themselves pinpoint the risks facing their businesses in their annual reports, as described in Chapter 12, it’s often better to get this information from a credit-rating agency report. Bond investors are a pretty nervous bunch, because they’re petrified of not getting their money back. As a result, credit-rating agencies spend a great deal of time investigating things that could go wrong at a company instead of what could go right.

Getting your hands on the credit rating

If you thought getting stock analyst reports was convoluted, that was simple compared with getting a credit-rating agency’s report. Generally speaking, you’ll need to contact your broker directly to get a copy of the credit-rating report.

However, there are some online resources that will help you get what you need from the reports, including the:

• Credit-rating agencies’ sites: Both Moody’s site (www.moodys.com) and S&P’s site (www.spglobal.com) let you look up the rating on most stocks for free. You just need to register, which is free. If you need the full reports, you’ll need to contact the agencies yourself.

  Both Moody’s and S&P provide free access to some of their broader analysis on trends in the credit market. These reports can be helpful with fundamental analysis of stocks, too, because they pinpoint many of the concerns bond investors have with the economy in general.

• Media reports: Most major news outlets have real-time access to the credit-rating agencies’ full reports and routinely issue stories on them. News outlets also have access to personnel at the rating agencies and can ask questions that go beyond what’s contained in the reports. For instance, when ADP’s credit rating was cut by S&P, there were many media reports providing a summary of the key information in the report. If you want to review how to use news reports to bolster your fundamental analysis, flip back to Chapter 13.

Knowing when a company’s credit rating is suspect

It’s never a good idea to take any analyst’s report on a company as undisputed fact. Analyst reports are based on a heavy dose of estimation. Credit-rating agencies’ reports and credit ratings are no exceptions. Fundamental analysts need to read these reports and decide where they agree or disagree. You can also find out when other bond investors are a bit dubious of the ratings the credit-ratings agencies gave to a company.

Companies’ debt, including their bonds, trades during the day like stocks. Just as stock investors buy and sell shares all day, bond investors buy and sell companies’ debt securities. The constant back-and-forth determines the price of bonds, just as trading determines a stock’s price.

Savvy fundamental analysts know how to check the price of a company’s debt and compare that to the prices of debt issued by other companies with similar credit ratings. If the prices on a company’s bonds are dramatically lower than those on debt issued by companies with the same credit ratings, fundamental analysts know investors think the company’s credit rating is too high. Similarly, if the prices of a company’s bonds are higher than its peers with the same credit ratings, investors are telling you they think the credit ratings are too low.

If you’re investing in a company’s stock, why should you care if its debt rating is too high? If a credit-rating agency ultimately decides to lower the credit rating on a company, or downgrade it, that could potentially increase the company’s borrowing costs in the future. Higher borrowing costs could increase a company’s interest expense and decrease its net profit in the future. Net profit, as you discovered in Chapter 5, is critically important to fundamental analysts.

There are several ways to see how a company’s bonds are trading to determine whether investors think the credit rating might fall.

One method to see whether bond investors trust the credit ratings is to look up bond prices using the website, called TRACE, operated by the securities regulator called Financial Industry Regulatory Authority, or FINRA. You can enter any company’s name and see the prices on its bonds here: https://finra-markets.morningstar.com/MarketData/Default.jsp.

To get started, scroll down a bit and look on the right side of the page. Just enter the name or ticker symbol of the bond issuer in the Issuer Name or Symbol/CUSIP blanks under the Quick Search heading (be sure “Corporate” is selected since we’re talking about companies’ bonds here). Click the Search button and you’ll see a list of all the company’s bonds along with their prices and yields. You’ll want to compare these yields with those of bonds sold by competitors with similar ratings.

There’s an easy way to find out which companies are bond issuers that might be comparable to the company you’re analyzing. You can use Moody’s own site. Many parts of the site are free; you’ll just need to register. Here are step-by-step instructions on how to see companies’ competitors and their bond ratings:

1. Log into moodys.com.

   You will just need to enter your username and password.

2. Search for the company’s rating.

   Enter the name or ticker symbol of the company in the search box at the top of the screen. Click the company’s name when it pops up.

3. Click the Sector tab.

   When you do this, you’ll see a list of reports on all the companies that compete with the company you’re studying and their credit ratings in many cases.

4. Interpret the results.

   Search through the list for companies that have similar long-term ratings as the company you’re studying. Flip back to the TRACE system and enter the competitors’ bonds and see how they’re being priced. If the yields of the bonds sold by the company you’re interested in and its rivals’ are very different, the market is telling you something about its faith in the ratings.

The origins of social investing

Social investing traces its roots to the late 1990s with the rather primitive and crude concept of stock message boards. These online sites allowed investors to anonymously share ideas and hunches about stocks. When stock message boards started, they were a unique opportunity for investors to congregate and share ideas.

However, the obvious problems with these stock message boards quickly turned them into the investing equivalent of locker room gossip. Touts, or investors who try to artificially promote a company, would talk up a company’s future with the hope of dumping their holdings at a profit to naïve investors. Likewise, shorts, or investors betting a company’s stock would fall, could easily spread false rumors about a company and try to drive the stock price down.

Stock message boards are filled with all the things you, as a fundamental analyst, are trying to avoid. Rather than analysis based on fact, data, and analysts, the boards are stocked with amateurs just trying to spread false rumors and baseless allegations about stocks. Such rumor-mongering in stock message boards is especially problematic with stocks that don’t trade on a major stock market exchange.

Social investing has since evolved quite a bit. Today, there are social networking sites, which I’ll discuss in a bit, that let you see actual trades made by other investors. These sites allow you to find other investors that have similar investing strategies, such as fundamental analysis, and trade notes and ideas. There are other types of social networking sites that compile the investment ideas of many other investors into a single report, which I’ll discuss in this section, too.

Why it might be worth paying attention to nonprofessionals

It might seem counterintuitive and even a little amateurish to pay any attention to what lay investors think about a stock. That’s mostly true. But, as a fundamental analyst, you want to make sure you have examined a company and stock from every direction. If a nonprofessional can direct you to a gap in your fundamental analysis, you might be better off as a result.

Some of the areas where social investing may be worthwhile for a fundamental analyst include:

• Local demand information: Some social networking sites allow investors to share potentially valuable information, such as how crowded a restaurant chain’s locations are in various cities or how busy a retailer’s stores are. This type of information, if reliable, may serve the same purpose as an analyst’s channel check.
• Industry insight: Sometimes, investors who participate in social investing sites may work at companies that buy gear from a company you’re interested in. Their comments on the quality of a company’s products or demand for the products can be useful.
• Employees’ dirty laundry: Sometimes, employees will log into social investing sites and provide data that may be helpful in fundamental analysis. For instance, between 1997 and 2001, there were more than 100 posts on a stock message board about Enron, many that outlined potential problems at the firm, according to research from James Felton and Jongchai Kim in their article “Warnings from the Enron Message Board.” Some were startlingly prescient, including one in April 2001 that said Enron “is nothing more than a house of cards.” At the time of that post, most Wall Street analysts rated Enron a “buy” or “strong buy.”

How to plug into social networking

Unlike financial statement analysis, getting started in social networking doesn’t require any training. You just log into a website and get started. A few types of stock message boards and social networking sites to consider include:

• Stock message boards: The more popular stock message boards include those hosted by Yahoo! Finance (finance.yahoo.com) and Silicon Investor (siliconinvestor.com). Again, these stock message boards are filled with misinformation, so it’s caveat emptor. There are better options now.
• Reddit: Reddit is a popular online forum for investors to talk about just about anything. And yes, that includes stocks. Online conversations are organized into subreddits, or categories where people intensely interested in specific topics go. The go-to subreddit for stocks for now is found at wallstreetbets. From Reddit.com, after logging in, search for wallstreetbets and ask to be added to the often lively discussion.
• Twitter: Twitter has emerged as the go-to place for investors who want to yack about stocks. The online service allows investors to send short messages about their investments or ideas about companies. It’s easy to get overwhelmed by Twitter given the sheer volume of messages, or tweets, on there. Just know investors have a trick. When tweeting about a specific company, investors put a dollar sign and then the ticker symbol. So if you want to see all the tweets about Apple, for instance, search Twitter for $AAPL.

• Compilation sites and dedicated social networking sites: Some sites try to spare you from having to read through thousands of messages posted by various members of social networking sites. LikeFolio (https://home.likefolio.com) scours the Twitterverse to show you which stocks are getting talked about the most on Twitter and what people are saying about them. The service is expensive to subscribe to, however. Stocktwits (https://stocktwits.com) is another website that attempts to summarize everything that’s being discussed on Twitter about specific stocks.

  Another extremely valuable site for fundamental analysts is Estimize (www.estimize.com). The site, which is free to use, allows investors to enter their guesses for what a company will earn in future quarters and years. It’s a helpful tool because it gives you something else, other than Wall Street analysts, to compare your estimates with.

Following the moves of big-time investors

If monitoring the fundamental analysis by amateur investors isn’t all that appealing, you might still be curious what the Warren Buffetts of the world are doing. Sometimes these pros take to Twitter to share their views. Buffett’s official Twitter account is at https://twitter.com/WarrenBuffett. Carl Icahn, another investor known for doing his homework, is active on Twitter at https://twitter.com/Carl_C_Icahn.

But there’s another way to see what big-time investors are thinking. Using financial documents, you can extend your fundamental analysis to find out what other famous investors are doing with their money. And yes, you can find out whether a stock you’re interested in is owned by famous investors including Warren Buffett or well-known portfolio managers of mutual funds that use fundamental analysis.