Investors often rely on the recommendations of Wall Street analysts when deciding whether to buy, sell or hold stocks. Media reports about these analysts employed by brokerage firms (or by the sell-side) changing their ratings often have an impact on the stock price. Do they really matter though?
Let’s take a look at what these Wall Street heavyweights have to say Nvidia (NVDA) before discussing the reliability of broker recommendations and how to use them to your advantage.
Nvidia currently has an average brokerage recommendation (ABR) of 1.20 on a scale of 1 to 5 (strong buy to strong sell), calculated based on the actual recommendations (buy, hold, sell, etc.) made by 40 brokerages companies. An ABR of 1.20 is roughly between a strong buy and a buy.
Of the 40 recommendations stemming from the current ABR, 35 are Strong Buy and two are Buy. Strong Buy and Buy account for 87.5% and 5% of all recommendations, respectively.
Check Nvidia stock price target and forecast here>>>
ABR suggests buying Nvidia, but making an investment decision based on this information alone may not be a good idea. According to several studies, brokerage recommendations have little or no success in directing investors to select stocks with the greatest upside potential.
Are you wondering why? Brokerage firms’ personal interest in a stock they cover often results in a strong positive bias in their analysts’ valuations. Our research shows that for every Strong Sell recommendation, brokerage firms assign five Strong Buy recommendations.
In other words, their interests are not always aligned with retail investors, rarely indicating where a stock’s price might actually be headed. Therefore, the best use of this information may be to validate your own research or an indicator that has proven to be very successful in predicting stock price movements.
Zacks Rank, our proprietary stock rating tool with an impressive externally audited track record, categorizes stocks into five groups ranging from Zacks Rank #1 (Strong Buy) to Zacks Rank #5 (Strong Sell) and is an effective indicator of stock price performance in near future. Therefore, using ABR to validate Zacks Rank can be an effective way to make a profitable investment decision.
The Zacks Rank should not be confused with the ABR
Despite the fact that Zacks Rank and ABR appear on a scale of 1 to 5, they are two completely different measures.
ABR is calculated solely based on broker recommendations and is usually shown in decimals (example: 1.28). In contrast, the Zacks Rank is a quantitative model that allows investors to harness the strength of earnings estimate revisions. It is displayed as whole numbers — 1 to 5.
Analysts employed by brokerage firms have been and continue to be overly optimistic with their recommendations. Because the ratings issued by these analysts are more favorable than their research would warrant due to the self-interest of their employers, they mislead investors far more often than they direct.
On the other hand, earnings estimate revisions underlie Zacks Rank. And empirical research shows a strong relationship between trends in earnings forecast revisions and short-term stock price movements.
In addition, the various Zacks Ranks are applied pro rata to all stocks for which brokerage analysts provide earnings estimates for the current year. In other words, at all times this tool maintains a balance between the five ranks it assigns.
There is also a key difference between ABR and Zacks Rank when it comes to freshness. When you look at the ABR, it may not be up to date. Nevertheless, since brokerage analysts constantly revise their earnings forecasts to reflect changing business trends, and their actions are reflected in the Zacks Rank quickly enough, it is always timely to predict future stock prices.
Is NVDA a good investment?
Looking at revisions to Nvidia’s earnings forecast, the Zacks Consensus Estimate for the current year has increased 16.4% over the past month to $23.22.
Analysts’ growing optimism about the company’s earnings outlook, as indicated by strong consensus among them to revise higher EPS estimates, could be a legitimate reason for the stock to surge in the near term.
The size of the recent consensus estimate change, along with three other factors related to earnings estimates, has resulted in a Zacks Rank #1 (Strong Buy) for Nvidia. You can see the full list of today’s Zacks Rank #1 (Strong Buy) stocks here >>>>
Therefore, the buy-equivalent ABR for Nvidia can serve as a useful guide for investors.
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