Can you trust broker 'buy' recommendations for UK shares?

FTSE 100 firms with the high percentage of ‘buy’ ratings under-performed.

FTSE 100 firms with the highest percentage of ‘buy’ ratings by analysts underperformed the index as a whole in 2017, according to new research released by AJ Bell.

Worse still, five of the 10 most widely tipped stocks produced negative returns in 2017. This is the second year in a row that broker ‘buy ratings’ have flopped, calling into question whether such tips are worth the paper they are written on. 

For example, Shire, received a buy rating from 86 per cent of brokers – the highest percentage for any firm in the FTSE 100 in 2017. However, over the year it saw a negative share price return (not including dividends) of -16.7 per cent. The worst tip proved to be Provident Financial, which tanked  -68.86 per cent.

Overall, the 10 FTSE 100 companies with the highest proportion of ‘buy’ ratings at the start of 2017 lost -9.3 per cent over the year. By contrast, the FTSE 100 produced an overall return of 7.6 per cent. 

At the same time, the 10 FTSE 100 firms with the highest percentage of ‘sell’ ratings last year collectively performed better than the rest of FTSE 100 index. Rolls Royce, the firm with the second highest sell rating in the FTSE 100, actually saw gains of 28.5 per cent. 

Other mismatches between share price performance and rating can in certain cases be attributed to wider macro trends. Mining company Antofagasta, for instance had a sell rating of 44 per cent,, however, it produced a return of 48.9 per cent – reflective of a general uptick in mining sector performance last year. 

Overall, investors would have been better off buying the most ‘sell’ rated FTSE 100 firms. On average, the top 10 produced a return of 9. 5 per cent, compared to FTSE 100’s 7.6 per cent. 

According to Russ Mould of AJ Bell, the poor performance of the most ‘buy’ rated shares shows that ‘the well-informed, diligent, expert broking community has little more idea of what is coming than anyone else, at least in the short term.’

However, for anyone convinced to go it alone and pick their own stocks based on this research, Mould has a warning: ‘thoroughly research any company for themselves before they even think about buying it shares.’

Mould recommends the four advice points of successful American investor Charlie Munger – Warren Buffett’s vice-chairman at Berkshire Hathaway:

One, do you understand the business?

Two, does the business have intrinsic value or durable competitive value?

Three, does management have integrity?

Four, does the stock come at a reasonable valuation?

‘Don’t read into it too much’

Oliver Smith, portfolio manager at IG, however, cautions against completely dismissing analysts based on the findings. While noting that the research ‘does not bode well for the content and conclusions of broker notes,’ it should be remembered that ‘it is not the job of an analyst to pick the best performing stocks in the market.’

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Instead, analysts task is to pick the ‘best stocks within their sector,’ as well as looking to ‘generate new investment angles that their clients may not have thought of,’ says Smith. ‘Analyst notes provide a host of useful information, and for small caps are often the only way to get any detailed information on a company at all.’

Smith also points out that the AJ Bell research does not include dividends paid by companies mentioned. 

Neil Shah director of research at Edison Investment Research also cautions against drawing too many conclusions from the research: ‘Overall I would be wary of reading too much into one year’s findings’. However, he notes, ‘if this pattern was repeated over a decade then it might be more interesting.’

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