Analysts' stock picks may not be best buys
I respect Wall Street analysts, honestly I do. But I wouldn't let them pick stocks for me.
In May 2012, I wrote a column on five stocks that analysts liked but I didn't: Nielson Holdings N.V. (NLSN), Starwood Hotels & Resorts Worldwide Inc. (HOT), Simon Property Group Inc. (SPG), American Tower Corp. (AMT) and Gartner Inc. (IT).
All were rated a buy by most analysts, but I didn't like them because of what I viewed as excessive valuations, or weak balance sheets, or both.
From May 29, 2012, through June 28, 2013, those five stocks returned 19.5 percent, while the Standard & Poor's 500 Index notched a 23.6 percent return. Both figures are total returns including dividends.
Candidly, the stocks did a bit better than I expected. Yet, despite their favored status on Wall Street, they trailed the market.
Analysts are good at spotting operational trends at companies. They know which new product is succeeding or fizzling, who is on the inside track to become chief executive and whether a company is gaining ground on competitors or losing ground.
As stock pickers, however, analysts are typically no better than average. They overemphasize recent results and trends and pay too little attention to how expensive a stock is. I also think they tolerate high corporate debt a little too easily.
They have a potential source of bias because they have incentives to be generous with “buy” ratings. Their firms get commissions from trading and fees from handling stock and bond issues. Companies are more likely to hand such plums to a firm that has said good things about its stock.
By Wall Street custom, a strong buy rating is tabulated as a 5 on a 5-point scale. A regular buy rating is a 4. A “hold” or “neutral” rating counts as a 3, while sell ratings are a 2 or a 1.
Currently, 82 percent of the stocks with a market value of $1 billion or more have a consensus analysts' rating of 3 or higher. And 37 percent are rated 4 or higher.
Those are some reasons why I value analysts for the information they provide, but not for their stock picking prowess.
I will attempt to prove my point of view by extending the little experiment from last year's article. So here is my second list of stocks that analysts like and I don't.
• Oxford Industries Inc. (OXM), based in Atlanta, makes men's, women's and children's clothing. All seven analysts who follow it give it a strong buy rating. I have worn its shirts, but I wouldn't own its shares right now.
The dividend is skimpy, at slightly more than 1 percent. The valuation is generous: 28 times recent earnings. That is higher than the price/earnings ratio on Google Inc., 26. Yet Oxford is expected to earn less this year than it did in 2006 and 2011.
• Macquarie Infrastructure Co. (MIC) is a small New York conglomerate whose biggest subsidiary is Atlantic Aviation, an airport services company. Of seven analysts who rate it, five award it a buy rating.
Yet Macquarie posted losses in four of its nine years as a public company. This year, analysts look for $1.56 a share in earnings; if true, the stock fetches 36 times expected 2013 earnings, and 27 times the $2.08 print expected for 2014. That's paying a lot for a bird that's still in the bush.
• Targa Resources Corp. of Houston, Texas, runs a limited partnership that processes and transports natural gas and provides other services to gas producers. Nine of 14 analysts give it the thumbs up. I like several things about Targa, but hate its debt-to-equity ratio of about 17 to 1.
• Royal Caribbean Cruises Ltd. of Miami is followed by a huge pack of analysts, 33. Of those, 20 rate it a buy. I do believe the cruise business will improve the next few years, but slowly, not dramatically.
• Finally, I am skeptical of Las Vegas Sands Corp. (LVS), the operator of a hugely successful casino in Macao, China, and other casinos in Las Vegas and Singapore. Of 29 analysts covering it, 26 rate it a buy.
My concerns: The Chinese economy is slowing, which can't be a plus for the Sands in Macao. The stock, up 49 percent in the past 12 months, sells for six times book value, almost four times revenue, and 26 times earnings. Investors appear to think that nothing can go wrong.
John Dorfman is chairman of Thunderstorm Capital LLC in Boston. He can be reached at firstname.lastname@example.org.