What Financial Report Readers Should Know about Stock Ratings - dummies

What Financial Report Readers Should Know about Stock Ratings

By Lita Epstein

Financial report readers should be aware of stock ratings, but use the information with caution. Stock ratings for general public consumption are primarily done by sell-side analysts, who seem to err on the side of optimism.

You rarely find a stock with a sell rating (a recommendation to sell the stock). In fact, when analysts testified in Congress after the analyst scandals in the early 2000s, one analyst was heard saying that everybody on Wall Street knows that a hold rating (which is intended to mean you should hold the stock but probably not buy more) really means to sell.

Some firms use an accumulate rating, which you may think means to hold on to the stock or maybe even add more shares, but really means to sell in behind-the-scenes circles on Wall Street.

Just like with bond ratings, each firm has its own vocabulary when rating stocks. A strong buy from one firm may be called a buy in another firm and may be on the recommended list in a third firm.

You can never know which company is right, but after following a firm’s stock ratings for a while, you can understand how its systems work and how accurate it is compared with what actually happens to the price on the stock market.

Because various companies’ rankings may differ dramatically, you need to check out ratings from several different firms and research what each firm means by its ratings. A stock that’s rated as a “market outperformer” may sound pretty good, but in reality, it’s probably not a good investment, which may become clear when you compare rankings of other firms and find that they consider the stock a “neutral” or “hold” stock.

Many financial report readers don’t put much faith in the stock analyst rating system, and you shouldn’t, either. As you start doing independent research on a company after reading its financial reports, take everything you read with a grain of salt. Collect all the information you can and then do your own analysis.