20 – M4 L1B 21 Analyst Ratings V1

Analysts factors are derived from the published reports of sell-side research analysts at investment banks. Their reports include ratings such as buy, hold, or sell. They also include earnings estimates or price targets for the stock. Sell-side analysts may be assigned to a few companies within the same industry, and may even meet with the management of the companies that they evaluate. This research is intended for buy-side investment firms such as mutual funds and hedge funds, who execute their trades with these sell-side investment banks. Since many large investment firms value the opinions or research analysts, their published analysis can have significant effects on stock trading. If you read financial news and the news mentioned that a particular stock has a buy or hold rating, this is likely an average rating of multiple research analysts. We may also refer to analyst ratings as a kind of sentiment factor because each research analysts aggregates their information about the company’s financials, it’s growth prospects as well as its current price, and then summarizes this into the analysts overall conclusion or sentiment about that stock. Investment banks choose their own rating scale. For example, one has buy, neutral, or sell. Another has overweight, equal weight, underweight, or more volatile. Yet another has trading by, recommended list, market out performer, market performer and market underperformer. Sell-side ratings are usually aggregated to create a consensus sentiment about a particular stock. It’s also useful to focus on when analysts change their ratings. For example, if multiple analysts start changing their ratings of a stock from hold to sell, we might expect investors who follow analyst ratings to start selling that stock. Analyst ratings may experience a heard mentality. It’s difficult for a single analyst to publish a sell rating when most other analysts in the industry are publishing a buy rating. In other words, it’s safer to be wrong when everyone else is also wrong, but more costly for an analyst to be wrong when everyone else is right. So instead of taking a simple average of analyst ratings, it may be useful to focus on the most reputable star analysts and give their ratings more weight. One way to combine analyst sentiment into a trading signal is to aggregate all the ratings that have changed over a certain period such as the past three months. If we count all the ratings upgrades and subtract all the ratings downgrades, then we have a number that is either positive, negative or 0. A positive number represents a positive sentiment, whereas a negative number is a negative sentiment. To rescale this sentiment between negative 1 and 1, we could divide this number by the total number of analysts that we’re tracking, whether they upgraded, downgraded or cut their rating the same.

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