What Investors Need to Know about Financial Analysts

Most investors rely heavily on financial analysts' reports and recommendations about securities. Trading activities and stock prices are very responsive to securities analysts' recommendations. A well-known research analyst, for instance, need only mention a company's market performance on national TV for that company's trading volume and stock prices to pick up or fall immediately after. It doesn't even matter whether the securities analyst made a definite recommendation or not.

Financial analysts study securities.

Financial analysts are professionals who study publicly traded companies and rate their market performance. They disseminate the results of their study to the public through print, TV, radio, and internet media. Some financial analysts may also undertake private commissions. In such studies, the results may or may not be made public.

Financial analysts are usually specialists.

Research analysts vary by specialization. Some research analysts specialize in equities; they are known as equity analysts. There are also analysts that specialize in bonds market; predictably, they are known as bond analysts. There can be as many types of financial analysts as there are different types of securities.

The subject of a financial analyst's study may be general or specific. For instance, a securities analyst can choose to study the mortgage market in general. They can also focus on specific companies that issue mortgage-related securities.

Financial analysts' ratings are context-specific.

Financial analysts vary by specific methods of study. Their criteria for rating companies also often vary.

Financial analysts also use differing study parameters. For instance, one research analyst can opt to make recommendations based on a company's performance in the last 3 months. Another financial analyst, in his study of the same company, can choose to take a longer-term approach.

What does this mean for investors? Before acting on a research analyst's recommendations, you should read the analyst's report in full. Specifically, you should determine the ratings criteria, study time frame and research methods used. Use this information to situate the analyst's recommendation in its proper context.

Financial analysts' ratings may be the same but they can mean different things.

Financial analysts rate securities. Financial analysts typically use terms like "buy," "outperform," "hold," "underperform," and "sell" to express their ratings.

You should not take such ratings at face value. An analyst's definition of "buy" can be different from the "buy" rating of another analyst. Therefore, if an analyst says you should "buy" a specific company's stocks, find out first how that analyst defines this rating before you comply.

Financial analysts may not always be objective.

A financial analyst's recommendations may be influenced by his or her affiliations. Check out the example below to see how this can happen.

Example:

A financial analyst works for a brokerage firm that provides investment banking services to companies. Company A, one of the companies he covers in his analysis, is an investment banking client of his brokerage firm.

After conducting his research on Company A, he finds out that this company's financial situation is tenuous at best. He also predicts that this will not improve in the months to come.

If he were to be objective in his assessment, he would recommend that the brokerage firm's investor clients sell their Company A shares. However, he can't ignore the fact that Company A is one of his brokerage firm's biggest clients. Consequently, he takes a neutral or even "buy" stance.

You should always try to uncover potential sources of bias when relying on a financial analyst's report for trading decisions. Knowing about potential sources of conflict will help you assess whether or not to trust what an analyst recommends.

Financial analysts may be wrong.

Securities analysts can make mistakes. They may be good at what they do and they may be experts when it comes to predicting market movements. Nevertheless, there are things they can't foresee that can influence a company's market performance.

Conclusion

Financial analysts provide investors with a valuable service. Their recommendations help investors make trading decisions. Their service is especially valuable to inexperienced investors.

If you are serious about investing in securities, however, you should not rely so much on financial analysts' reports. If you are interested in a specific company, you can do your own research. Among other things, you can

• obtain a copy of a company's financial statements/prospectus/other corporate filings,
• observe the company's performance for a few months,
• check out its performance in the past, and
• study market trends.

After doing the above, you can probably make your own investment decisions. You can still read financial analysts' reports, of course. Use them to improve your analytical skills and to verify your own findings.

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