Corporate Balance Sheets

Sell-Side Analysts
The sell-side analysts are busy trying to calm the masses these days.  These are the people we see on TV all of the time giving their valuations for sectors and companies.  The thing we need to remember is their job is to make certain sectors and companies look attractive enough for retail investors to want to buy them.  Since it is unlikely analysts can follow the whole universe of companies all of the time, their recommendations will often be relative to the things they do follow. 

Buy, or Sell?
For example lets pretend I am one of these analysts, and I follow the telecom sector.  Since I have to have more buy recommendations than sell recommendations (people won't buy companies with a sell recommendation), it would be easy to recommend AT&T and Bell Canada.  Normally, energy, gold, and agricultural companies do better during this time of year.  Arguably, Suncor, and Potash are likely to do better over the next few months.  As an analyst my top picks come from those companies that I do follow, even though the other one's are likely to outperform, or have better valuations.

Buy & Sell Strategies
That is how, in 2008, we went from everybody telling us not to sell, to everybody telling us it was too late to sell, practically overnight.  Now I am not saying that what we are currently experiencing is on a par with the last financial crisis, but I don't look to the analysts to tell me when to sell.  I have a buying strategy, and I have a selling strategy, and I follow them as the markets gyrate up and down.  My strategies allow me to make money even in down markets, and they also allow me to sleep at night.
   
Recession, What Recession?
I am not sitting in judgement of the analysts, just saying that is what they do.  So when we hear them saying there is no risk of a double-dip recession, and they are all saying it, I start to get cautious.  First, when everybody seems to be taking the same side of the argument, that is a caution sign.  Second, when they say the reason we can't be headed into recession, again, is because of the pristine balance sheets for almost every company across North America, my intuition kicks in.

Spending
Around seventy percent of the U.S. economy depends on consumer spending.  Just over 10 percent comes from corporate investment.  That would imply that for every dollar consumers don't spend (because they can't spend what they don't have), corporations would have to increase their spending by seven!  Why would companies do that in the current environment?  Given the uncertainty, the lack of consumption, and the difficult economic environment, what would cause U.S. companies to go on that much of a spending spree?

China
While China is seen as saving the world economy, the U.S. imports almost four times as much from China as it exports to China.  How are U.S. companies going to make up for the lack of sales of imports (i.e.: lack of consumer spending)?  China, basically, imports from other Asian economies, and exports to the U.S..  Reversing that flow isn't suddenly going to happen.

Advanced Planning
I try to keep in mind that most of what we hear in the media is "sales talk".  I should determine, in advance, the conditions under which I should buy and those under which I should sell.  That will prevent me from being at the mercy of the sales pitches and the obvious but irrelevant arguments constantly playing out in the media.

Have you formulated your buy and sell strategies in advance?

         

Analyst Ratings

Analyst ratings are not useful in helping us determine if we should buy a stock.  A buy rating by itself means nothing.  How and when an analyst changes their rating can be informative, but I never go by ratings.

Analysts are real people too.  They only have so much time in the day, just like you and I.  There is no possible way an analyst can provide ratings for hundreds and hundreds of stocks.  Jim Cramer on CNBC's Mad Money recommends we spend at least an hour a week on each stock we invest in.  The point is even an analyst can only rate a limited number of companies.

Buy-side analysts research companies for fund managers.  The purpose of a sell-side analyst is to provide a compelling case for owning particular stocks.  If there is only so much time in the day, then some of that time can be used to rule out some of the candidates, but the remainder of the time has to be spent building a case for buying others.  In a finite universe of companies, some will always be sells, some holds, and others buys.  In other words, it is less about absolute performance, and more about relative performance - how one company will perform compared to another.  If we are in the middle of a bear market and the prices of stocks are plummeting, it is cold comfort to know that my stock has crashed to a lesser degree than a competing stock.

Yet, the analyst always has to have a buy recommendation.  That is their job!  In addition, analysts work for firms that have business relations with companies that want to go public, or issue new shares, or raise money using their services.  When an investment firm provides money to a company for an initial public offering (IPO), the investment firm needs to find buyers for the stock.  Have you ever received one of those calls where some advisor you have never met before wants you to buy the hottest stock since, well, ever?

Analyst ratings affect the price.  Watch for times when an analyst has it wrong and continues to raise their target price despite not liking the stock.  At some point that same stock could get so strong relative to their other ratings, they have to change from a sell, or a hold, to a buy.  When that happens, it will normally be good for the price of the stock.  Watch for any change in earnings estimates.  That is a good time to reevaluate our own target price and how many shares of a stock we might want to own, if any.

I aggregate the earnings estimates to determine a fair price for a company's stock.  If there is a herd instinct among buyers, it can also be said for analysts.  When everyone is saying the same thing, I check for alternative scenarios.  I would never buy on somebody else's say-so, and especially not on an analyst's buy rating.

Do you use analyst ratings?

Price Earnings Ratio

Price = earnings times average p/e ratio

Personally, I would never consider buying stocks in a company simply based on the recommendation of someone else.  Still, I get questions from friends about buying this stock, or that, based on a phone call they received from some "well-intentioned advisor".  Usually the story is pretty compelling, and there is always a sense of urgency to get in before it is too late.

While I struggle to comprehend the value provided by sell-side analysts, I suppose their value is not lost on firms trying to engineer the case for buying the next hot stock.

There is one piece of information those analysts provide which I do use.  It is the annual earnings number.  These people know and follow their companies better than I ever could.  They crunch the numbers and come up with an estimate for company earnings for the end of the next year.  I don't rely on any one estimate, but I do look at the average of all of the estimates for a company.

For that reason alone, if a company does not have an analyst following it, I won't buy it.  I am only interested in owning companies with a long enough track record and sufficient size to have analyst coverage.  How else can we put any probability on what the company is going to do in the future?  How many times have I seen people lose money in the stock of companies that never made a single cent?  Never mind the hype and the hyperbole, show me the money!

Did you pay full price for the vehicle you are currently driving?  If so, why?  They want our business, and will make concessions to get it.  Do you buy groceries and pay full price when you know there is a sale coming up for the same items, or a coupon which is good at a future date?  Why should we purchase any stock unless it is on sale?

Any company I would be interested in, has to have a track record, have a couple of analysts covering it, and it has to have made money for, at least, a few years.  I have no desire to own penny stocks, or hopeful wannabe's.  The companies I want to own have a great, if not the best track record in their market.  Since I know the future earnings numbers and I also have historical price to earnings ratios, I can calculate what the price of a single stock is worth.  Earnings per share multiplied by the historical average for the price/earnings ratio equals what the stock is worth.  If that is the current price, why would I buy it?  The lower the current price is below the result of my little calculation, the more interested I become.

Don't take the recommendations of other people, especially those trying to sell something.  We need to do our own homework, and calculate what the stock is worth.  Myself, I still wouldn't run to the computer and buy it without, first, doing some technical analysis to figure out a good point in time to buy.  Regardless, unless it is on sale, I won't even consider it.