If share investors have learnt anything meaningful this year, it’s a reminder of how unforeseen regulatory and policy changes can disrupt markets in a manner not unlike more sinister black swan events. For example, myriad policies by United States President Donald Trump this year – notably trade tariffs – have had huge implications for corporate earnings.
So much so that any broker recommendations, written a day before Trump’s so-called Liberation Day tariffs measures on 2 April – which resulted in a massive global market selloff – would have quickly been rendered obsolete.
Given that stock brokers are still seen by many as oracles with superior insights into future listed company performance, Azzet thought it was time to highlight some home truths around what they do and how they operate.
Broker research isn’t what it used to be
It’s true, broker research can help you learn a lot about stocks you might be looking to trade.
However, in the last decade or so, the number of broking firms conducting in-depth analysis of stocks has dwindled dramatically.
The spiralling costs associated with broker research mean the gravitas often given to broker reports has lost its gloss.
As a result, the sheer number of stocks now covered by brokers seldom goes beyond the ASX300 large caps that move the market on any given day.
While 133 companies within the ASX200 are covered by as many as 10 analysts, another 53 companies have up to four analysts mauling over their half- and full-year results.
In other words, around 87% of the 2,200-plus companies that trade in the ASX go under the radar of any broker analysis.
Mining giant BHP (ASX: BHP), which has a market value of close to $200 billion, attracts the most focus with 29 analysts covering the stock.
This puts the onus on you, the investor, to unearth medium or small-cap stocks well on their way to becoming the next CSR (ASX: CSR) or BHP (ASX:BHP).
Ignore valuations and recommendations
For starters, it’s important to understand that broker research is designed to generate trading ideas for the brokers - by delivering insights and perspectives - which in turn results in investors trading more regularly.
One way to benefit from their research is to learn what you can about a stock and the industry it operates in.
Given that research tends to be focused on the short-term, it’s often a good idea to ignore the valuations (price targets) and recommendations that accompany it.
Sticking to the fundamentals also means you won’t end up being bamboozled by differing recommendations and the price targets for the same stocks.
For example, right now there are Neutral, Overweight and Accumulate recommendations on BHP (ASX: BHP) and Equalweight, Neutral, Hold and Buy recommendations on Woolworths (ASX: WOW), to name just a couple.
It’s also good to look through confusing anomalies that broker analysis can often throw up, and this can occur when a Buy recommendation on a stock is accompanied by a negative expected return.
Remember, one of the reasons why you may disagree with the broker's recommendations comes down to the time horizon.
While you might be looking at total returns over five years, they won’t be looking much beyond the next 12 months.
On the flipside, a non-dividend-paying stock could end up with a Sell recommendation if the share price is expected to drop slightly over the next 12 months.
What recommendations mean
For added clarity, it’s important to know that terms like Overweight, Equal-weight and Underweight are very different from less ambiguous terms like Buy, Hold and Sell.
For example, Overweight typically means the stock’s total return is expected to exceed the average total return of the analyst’s industry coverage universe over the next 12-18 months.
As you may have noticed, brokers don’t like to make Sell recommendations willy-nilly, but when they do, it’s important to sit up and see if that makes for a base case to buy for the long-term or a bear case to avoid for now.
While slapping a Buy or a Sell recommendation on a stock may not move prices the way they used to, they can still make the market sit up when they come out and depending on who the broker is, they can still drive a headline.
Do broker recommendations add value?
In a note to clients earlier this year, stockbroker Angus Aitken concluded that 99% of analysts add zero value.
What Aitken takes issue with is the timeline gap between analysts and the rest of the market.
Unlike most investors who look longer term, he says the pressure on brokers to keep moving numbers and generate commissions means their analysts only focus on the short term.
According to Brian Johnson of MST Marquee, while a lot of brokers think their job is to tell you how much something is worth, the share price is only part of the equation.
“As you get older, you realise quality triumphs. Quality is what drives shareholder returns.” said Johnson, who notes that a spreadsheet model – the numbers – can only take you so far.
Interestingly, UBS has just started using AI to turn analysts into avatars, with videos of the simulated bankers going to clients.
"It’s not a parlour trick,” said Scott Solomon, head of global research technology at UBS.
“The [AI] tools at this stage are mainly productivity tools. A key driver of how much clients pay for research is how much time they spend with the analyst.”
