Analyst Ratings Changes, Your Propeller for Better Returns

The earnings season is one of the most crucial periods for investors. It provides insights into the financial health of a company. During this time, companies release their financial results, which include revenue, earnings, and other metrics that can influence stock prices. For this reason, investors tend to focus on the earnings season to make informed investment decisions. However, one thing that occurs during this season that is not often highlighted is the change in Analyst Ratings.

What Is an Analyst Rating/Recommendation?

An analyst rating is both a recommendation and advice issued by financial analysts or researchers to its clients concerning what assets to invest in - and what assets not to invest in. They range from a “Strong Buy” to a “Strong Sell” based on the consensus of the recommendation. These ratings also hold an influence on the perception of a stock, like if a stock is labeled a “Strong Sell”, investors would highly likely avoid the stock, or traders would “short” (borrow the stock from the broker and buy back at a lower cost and profit from the difference). Investors may find this in their brokers, financial websites, etc.

Change in the Rating?

The change in ratings occurs when one or some of the analysts change their bias/recommendation on the company, ultimately affecting the ratings or perception of most investors. These changes can allow investors to buy into companies with brighter prospects ahead of them.

For example, when an analyst from HSBC changed his view on NVDA from a “reduce” to a “buy,” NVDA jumped higher and made a 52-week high.

In the same way, when JP Morgan raised their rating for HP Inc and lowered Dell’s rating, it caused the price to gap up and trade higher.

Limitations on Analyst Ratings

Since analyst ratings are based on the fundamentals and future prospects of the company, investors should still note that it is never a foolproof method. Analysts can still make mistakes in their recommendations or assumptions. Investors should still consider what the consensus says. For example, if most analysts have changed from a “Hold” to a “Strong Sell,” then perhaps it's time for investors to think about liquidating their positions.

Now let’s look at analyst-covered companies and see how we can leverage potential changes in their rating using news, earnings release, etc.

Tesla Inc. (TSLA)

Tesla is Elon Musk's baby, and arguably his most important holding. Elon Musk has recently expressed his plans to launch his own AI platform, "TruthGPT” to rival ChatGPT, which Microsoft backs. Tesla is one of the players in the AI space and has been exploring automated driving by the use of AI using autopilot tells us that Tesla can be one of the beneficiaries of the new technology that Elon Musk plans to launch. Thus, it influences analyst perception of the company’s prospects.

With Tesla’s current rating as a “Moderate Buy,” further news on integrating AI into its products may help analysts estimate a brighter future for Tesla and raise their rating.

Booking Holdings Inc. (BKNG)

Another way investors can follow analyst sentiment changes is during earnings releases and earnings surprises. Analysts covering companies would generally have an estimate on the company's next earnings release. However, in some cases, companies beat market expectations and catch them by surprise. The bigger the “surprise,” the better it is for the company. These “surprises” can strongly influence analyst perception and recommendation as analysts use company fundamentals as one of the key factors in their recommendations. As a result, investors should note when a prospective stock will release earnings to capitalize on these potential opportunities.

Final Thoughts

Investing in companies that analysts have vetted is one way of simplifying any investor's investment process. However, it is still good practice to be able to read through other analyst recommendations and research to have a better grasp on the company’s prospects and financial health. In this environment where the market can switch directions automatically, due diligence is an investor's best friend.

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