Report Shows Analysts Are Terrible Stock Pickers

Last Updated Jan 11, 2011 12:31 PM EST

Here's a pretty solid stock tip: If you want a shot at the best stock returns, invest in the stocks Wall Street thinks stink. Bloomberg reported yesterday that since the market bottom of March 2009, stocks in the S&P 500 index that had the highest ratings from Wall Street analysts have risen an average of 73 percent. Yet the stocks that analysts hated the most rose more than twice that -- 165 percent.

And that's not some odd aberration. As the Wall Street Journal recently reported, there is a long-term pattern of outperformance by the stocks Wall Street hates the most. According to the WSJ, if you started with $10,000 in 2006 and invested $1,000 in the stocks with the most "buy" or "strong buy" recommendations (and the fewest sell/strong sell recommendations) at the beginning of each year, you would have nearly $11,000 today, assuming dividends are reinvested. If you had just stuck with an S&P 500 exchange-traded fund, you would have a smidge more: $11,150. And if you went completely against the grain and plunked your money in the ten least-loved stocks? Well, you would have $16,430. That's nearly 50 percent more than if you bet on the stocks Wall Street was the most bullish on.

Some takeaways from the two reports:

  • There's no such thing as the "wisdom of crowds" when it comes to picking stocks. The conventional wisdom can often be quite wrong, even when the wisdom is coming from a cadre of experts. A key problem is that even the experts tend to get tripped up by recency bias -- the human habit that compels us to assume that whatever has happened most recently -- either good or bad -- will persist. As my MoneyWatch colleague Conrad deAenlle reported, Wall Street is often blinded by its love of trends.

If you find yourself salivating over a seemingly can't-miss investment tip that is getting plenty of attention, the evidence from these two reports suggest the best move may be to run in the other direction. Or at least temper your enthusiasm. Give yourself a small stipend -- say no more than 5 percent of your portfolio -- to follow the hot trend. But keep the rest of your money tied to a long-term, diversified asset allocation strategy.

  • Love the unloved. So what are the analysts cold on for 2011? Brent Arends at the Wall Street Journal provided a list of those stocks with the lowest analyst ratings, according to Thomson Reuters. Here's an eye opener: Buffett's own Berkshire Hathaway makes the Top 10 list of the most unloved.

Wall Street's Most Unloved Stocks:

Source: Wall Street Journal

  • Even if you're right, it's hard to stay right. To be sure, there are indeed some analysts who make smart calls; Institutional Investor is just out with its top analysts for 2010. But being right consistently is no easy feat. As we all know too well from the ever-changing ranks of the top mutual funds from one year to the next, someone who is right over the short-term doesn't necessarily do well over the long-term. That's why it's nice to see that Morningstar's top fund managers for 2010 rewards long-term stalwarts, rather than short-term winners. Folks who've consistently made money over years, not quarters, are folks I'd consider listening to.

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