Interactive Investor

How to read between the lines of analyst research

1st April 2015 12:57

Ben Hobson from Stockopedia

Earnings season in the UK doesn't attract the same sense of fanfare that it does in the United States. With this year’s first rush of interim and annual results now out of the way, it will be equity analysts who are breathing the biggest collective sigh of relief. After all, it's their job to study financial reports in detail, judge performances and adjust forecasts accordingly.

Analyst research has a fairly mixed reputation among investors. Some see it as vital because the consensus - or average - opinion of analysts is a way of benchmarking a company's performance. It's the best (or perhaps least-worst) way of forecasting how a stock is likely to perform. Indeed, strategies of popular investors like Jim Slater rely on analyst forecasts to help predict expected growth rates.

Yet others are much more sceptical. Equity strategist James Montier once noted: "…analysts are terribly good at telling us what has just happened but of little use in telling us what is going to happen in the future."

Not only that, some worry about the credibility of company research and whether analysts can be truly objective. Of all the thousands of stock recommendations made each year, a disproportionately low 10% ever advise selling stocks. In other words, analysts are at best optimistic and tend to herd together for fear of making wayward forecasts. At worst, there are suggestions that this overwhelming positivity is influenced by the need to stay friendly with management (and perhaps secure lucrative future work) rather than issuing balanced opinions.

Analysing the analysts

So can you trust anything that analysts say? According to academic studies the answer is yes, but not necessarily for the reasons you might think. Rather than accepting stock research at face value, "analysis of analysts" has revealed hidden signals that are much more useful to investors.

One of them is to look closer at those stocks that are attracting the greatest level of revised earnings forecasts. Strong changes in sentiment, evidenced by large numbers of brokers upping their forecasts, have been found to be a useful predictor. Back in 2006 two academics, Phillip McKnight and Steven Todd, found that a portfolio of "earnings upgrade" stocks routinely produced positive returns.

They credited positive earnings revisions as being a trigger of price momentum. They found that as opposed to earnings downgrades, which were quickly priced-in, forecast upgrades took up to a year to make a full impact on share prices. They suggested that this was because investors were much more likely to take a wait-and-see approach to those upgrades.

Screening for upgrades

Stockopedia created a screen for Interactive Investor that looks for UK quoted shares that, over the past month, have had the largest upgrades to their earnings forecasts for the next financial year. We restricted the results to stocks that are ranking in the top 20% of the market for their overall combination of quality, value and momentum factors - which we call StockRanks.

Topping the list is hedge fund giant Man Group, which beat full year earnings forecasts when it reported its results in February. Even a cautious outlook hasn't dulled expectations, with the consensus of analysts raising their forecasts for Man by 21%. Internet betting exchange Betfair saw its shares jump earlier this month on an upbeat quarterly update. Like Man, brokers have been raising their forecasts on Betfair for the past five consecutive quarters, but the company's performance is still beating expectations.

UK lender OneSavings Bank (OSB), which floated on the market in 2014, announced in February that annual profits had more than doubled, leading to a 12% average increase in earnings forecasts. Elsewhere, small, speculative mining companies are largely out of favour with investors, but AIM quoted gemstone supplier Gemfields has sparkled of late. It recently reported an "exceptional" first-half performance, again prompting brokers to begin revising their forecasts.

The largest stock on the list in terms of market cap is International Consolidated Airlines, which runs British Airways and Iberia. It too has seen five consecutive quarters of earnings upgrades, including a 7.2% revision over the past month. The smallest stock is Alliance Pharma, the £97 million pharmaceutical products supplier. Its forecasts have been upgraded by 5% over the past month, and it also has the highest StockRank of 98 (out of 100).

NameMkt Cap £m% 1m EPS Upgrade FY2EPS Upgrade Streak# 1m UpgradesStock Rank™ 
Man3,54220.95887
Betfair2,0681351288
OneSavings Bank667.911.83484
Gemfields278.711.71289
International Consolidated Airlines12,2957.2751181
4imprint2886.973384
EVRAZ2,8275.93194
ITV10,1805.8811584
Alliance Pharma97.45.072198
Greggs1,0344.885493

For investors tempted to listen to analysts, it's worth remembering that in many respects this type of company research can be flawed. But reading between the lines may reveal hidden clues. Companies with the greatest earnings forecast upgrades can go on to enjoy periods of strong price momentum as the market slowly prices-in the latest news. In the frenetic weeks of earnings season, taking a different approach to analyst research could make it much more useful.

About Stockopedia

Interactive Investor's Stock Screening series is written by Ed Page Croft of Stockopedia.com, the rules-based stockmarket investing website. You can click here to read Richard Beddard's review of Stockopedia.com and learn more about the site.

● Interactive Investor readers can enjoy a two week free trial and £50 discount to Stockopedia using the coupon code iii014 - click here.

● To learn more about Ben Graham and his deep value investing strategies, you can download the free Stockopedia book, How to Make Money in Value Stocks.

It's worth remembering that these and other investment articles on Interactive Investor are simply for generating ideas and if you are thinking of investing they should only ever be a starting point for your own in-depth research before making a decision.

*No fee for publication is involved between Interactive Investor and Stockopedia for this column.

About the author

Ben Hobson is Strategies Editor at Stockopedia.com. His background is in business analysis and journalism.

Ben writes regularly on investment strategy performance and screening ideas for  Stockopedia. He is the author of several ebooks including "How to Make Money in Value Stocks"

interactive investor readers can get a free 14-day trial of Stockopedia here.

These investment articles are simply for generating ideas. If you are thinking of investing they should only ever be a starting point for your own in-depth research.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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