Chapter 18. Tips

Stockbroker analysts

Several stockbrokers employ analysts who pronounce on the merits or otherwise of companies with stock market quotations.

These analysts are required to pass examinations in order to register with the Financial Conduct Authority before they are allowed to make recommendations. The stockbrokers they work for will also be registered with the FCA and are required to ensure compliance with strict rules, particularly in terms of avoiding a conflict of interest.

Each analyst will cover a specific sector to build up expertise and each broker will cover a limited range of companies or sectors, or may specialise in covering just larger or only smaller companies. With about 2,000 companies quoted on the London Stock Exchange, including AIM companies, it would need quite an army to research and report on the lot.

Analysts do have access to directors of companies that they cover, especially when results are announced. Companies may hold analysts’ briefings to answer questions arising from results or trading statements. They may take them on site visits, say to a manufacturing facility or a retail outlet.

However, companies are not allowed to pass sensitive information to analysts in private. Anything that might affect the share price must be put into the public domain.

Apart from their specialised knowledge and expertise in reading company accounts and balance sheets, analysts have more time than most private investors to study all the details and to offer a considered assessment. It is, after all, their job. They are, though, human and like all experts they can get it wrong.

Analysts draw up reports on the companies they cover, assess strengths and weaknesses and make forecasts of turnover and profits for the current financial year and the next one.

They will make recommendations on whether investors should buy or sell the shares. These reports are sent privately to the stockbroker’s clients who have paid for the service. It is only fair that those who have paid up get first go at the assessment, but a summary of the week’s recommendations appears in various weekend newspapers as well as the Investors Chronicle and Shares magazine.

Interpretation of analysts’ recommendations

Analysts’ recommendations can be confusing because the terminology varies between brokers but generally they work on a scale from one to five, ranging from a confident buy recommendation, a less enthusiastic but still positive stance, a neutral position, a fairly negative position and a clear sell recommendation.

For clarity, the table below sets out most of the different expressions used.

Table 19: Terminology of analysts’ recommendations

You may wonder how it is possible to have different grades of buy or sell recommendations. Surely a buy is a buy and a sell is a sell?

Also confusing is that some analysts use ‘buy’ at the top end of the scale while others do not, and likewise they may or may not put ‘sell’ at the bottom of the scale. The lines can get a little blurred.

You would be quite right to raise such objections. Analysts, like the rest of us, can be mealy mouthed and hedge their bets. All you can assume is that analysts making a half-hearted buy or sell recommendation feel less sure they are right than if they went the whole hog.

The implication with a weak buy is that you should buy some shares but not too many. With a weak sell you could sell some but not all of your holdings. This intention is more clear when ‘add’ and ‘reduce’ are used.

The terms overweight and underweight cause confusion. The analyst is suggesting that you should hold more or fewer shares in a particular company than you normally would. For example, if you tend to invest £2,000 in each company in your portfolio, overweight would imply buying say £2,500 worth, while underweight would steer you to risking only £1,500.

Outperform, market performer and underperform are a bit of a cop-out. Instead of recommending whether you should buy or sell the shares, the analyst is assessing how they will fare in comparison with the rest of the stock market.

Supposing the market is steady, with little movement on the FTSE 100 or other indices. Then ‘outperform’ stocks will rise and ‘underperform’ stocks will fall if the analyst is right.

But if the stock market rises then even the ‘underperform’ stocks are likely to rise: they will just rise less than the rest of the market. In these circumstances an analyst can claim to have been right if an ‘underperform’ stock shows a modest rise.

Similarly if the stock market tumbles then even an outperforming stock can fall back.

As a general rule, treat ‘outperform’ as a buy indication and ‘underperform’ as a sell rating – but view them with more caution than an outright recommendation.

Analysts may also advise investors to avoid a particular stock. Well, that at least is perfectly clear: don’t buy the shares and if you already hold them sell them pronto. This is the strongest ‘sell’ recommendation of all, implying that you should not touch the shares with a bargepole.

Another recommendation occasionally seen is take profits, which is similar to ‘sell’ but with a subtle difference. A ‘sell’ recommendation implies that the company is doing badly; ‘take profits’ means that the shares have had a good run. The company is probably still in good shape; it is just that the shares have run up a little too quickly and might fall back to a more realistic level.

Finally, we occasionally see shares labelled as fair value or up with events. This is an alternative version of ‘hold’ or ‘neutral’ and indicates that the market has got this one about right. In the view of the analysts there are no compelling reasons to buy or sell these shares.

Can analysts be trusted?

So, analysts are experts but can we trust them? After all, the stockbrokers they work for are touting for trade among the companies they write about. Surely they are under pressure to be nice, especially to companies that are employing their colleagues as advisers.

There has been heavy criticism in the past over the role of analysts. Stockbrokers were supposed to operate what were called Chinese Walls between different parts of their business, with analysts blissfully unaware which companies their colleagues were advising or buying shares in.

Imaginary walls as thick as the Great Wall of China would not prevent information seeping through. This notion was as ludicrous as the Great Wall of China itself and proved just as useless, though both were erected at great expense.

Over the years the situation has improved. Analysts do declare prominently on their research notes when they work for the house stockbroker – that is, the broker retained to act for the company. Some brokers will issue research on companies where they are house broker but avoid making recommendations.

You should certainly err on the side of scepticism when reading research. In the case of house brokers you should consider whether recommendations ought to be downgraded one or two levels, assuming that ‘buy’ should really read ‘hold’ and ‘hold’ should read ‘sell’. It is rare indeed for a sell recommendation to emanate from a house broker.

Analysts at different stockbrokers can and do take different views of the same company. No one, not even the experts, gets it right all the time. Usually it is a difference between ‘buy’ from one analyst and ‘hold’ from another or between ‘hold’ and ‘sell’ – but occasionally one analyst sees the stock as a buy and another advises selling.

You may have noticed these occasional discrepancies in one of the Saturday or Sunday newspapers that summarise brokers’ tips.

You must, as always, use your own judgement. Try to assess whose arguments seem more convincing. Keep a note of these clashes and check later how the shares of the company in question fared. You may get a feel for which stockbroker tends to get it right more often.

Analysts tend to make far more buy recommendations than sell, as the former tends to generate more orders. Also they don’t win business from a company by telling investors to sell its shares!

Newspapers and magazines

The financial pages of the newspapers are excellent ways to keep in touch with events on the stock market and the economy in general. You probably buy a newspaper anyway, so the City pages come free.

Do try taking different papers, both on weekdays and on Sunday, to get a feel for which provides the level of City coverage that suits you.

Not all provide share tips. Among the dailies, Lex in the Financial Times, Tempus in The Times and Questor in The Daily Telegraph offer share tips. For the Sundays, Midas in the Mail on Sunday and Share Tips in The Sunday Telegraph tip individual shares. The Sunday Times has allowed one or two tips to creep into its Business section but it remains wary of making outright recommendations.

There are two weekly magazines with tips columns: the Investors Chronicle, published on Fridays, offers Mr Bearbull, while Shares magazine, now available only online, comes out on Thursdays and carries Plays of the Week. Both these magazines may carry tips in other sections.

The two magazines and some weekend newspapers also carry summaries of tips from stockbrokers.

Only a handful of financial journalists have passed any examination for registration with the Financial Conduct Authority, nor will the newspapers they write for be supervised by the FCA.

The Financial Services Act 1996 specifically absolved newspapers from the regulatory regime unless they were tip sheets – that is, they specifically existed to tip shares. We have seen since then the gradual disappearance or scaling back of share tipping from some publications to avoid attracting the attentions of the FCA (or its predecessor the FSA).

Newspapers therefore do not have to comply with stricter rules on matters such as avoiding a conflict of interest; any rules that are followed are voluntary ones set by the newspaper. This is unlikely to go beyond expecting any journalist writing on a company to declare to the City Editor any shareholding he or she has in that company.

Nonetheless, tip columns are edited by, and largely written by, financial journalists specialising in this field. I have written for three of the publications listed above and can vouch for the general integrity of their tips columns (though I will leave the readers to decide on their general success).

As with the analysts working for stockbrokers, you can find conflicting advice in newspaper tips columns. Once again, investors must use their own judgement to decide which arguments seem more convincing and which tipsters tend to get it right most of the time. Newspaper tipsters mercifully tend to be clearer and simpler in their categories of advice. You will mainly find ‘buy’, ‘hold’ and ‘sell’ – but you will also come across ‘avoid’ and ‘take profits’.

This last category is often qualified with the advice to sell half your shares and keep the other half. The reasoning is that if the shares fall back after a good run you have at least banked some profits at the top of the market. If the shares continue to rise, then you are still getting some benefit from the ones you hung on to.

One drawback with newspaper tips is that there is a fixed space available each day so a set number of companies, usually a maximum of three, will be covered irrespective of whether news and events justify the selection.

Also, share prices for companies tipped in the papers can move substantially immediately the stock exchange opens, so you may not be able to trade at the recommended price. This is particularly important if you ask your stockbroker to buy at best price – you may find yourself paying rather more than you intended, as traders have got in before you and bid the price up.