Read this before placing a bet

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?

Before we discuss the reliability of broker referrals and how to use them to your advantage, let’s see what these Wall Street heavy hitters think TSMC (TSM).

TSMC currently has an average brokerage recommendation (ABR) of 1.43 on a scale of 1 to 5 (strong buy to strong sell), calculated based on the actual recommendations (buy, hold, sell, etc.) made by seven brokerages companies. An ABR of 1.43 is roughly between strong buy and buy.

Of the seven recommendations that stem from the current ABR, five are a strong buy and one is a buy. Strong Buy and Buy respectively account for 71.4% and 14.3% of all recommendations.

TSM Broker Recommendation Trends

TSM Broker Rating Breakdown Table

Check TSMC stock price target and forecast here>>>

ABR suggests buying TSMC, 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? As a result of brokerage firms’ vested interest in a stock they cover, their analysts tend to rate it with a strong positive bias. According to our research, brokerage firms assign five Strong Buy recommendations for every Strong Sell recommendation.

This means that the interests of these institutions are not always aligned with those of retail investors, giving little insight into the direction of future share price movement. Therefore, it would be best to use this information to validate your own analysis or a tool that has proven to be very effective 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.

ABR should not be confused with Zacks Rank

Despite the fact that Zacks Rank and ABR appear on a scale of 1 to 5, they are two completely different measures.

The broker’s recommendations are the only basis for calculating the ABR, which is usually shown in decimals (such as 1.28). The Zacks Rank, on the other hand, is a quantitative model designed to harness the power of earnings forecast revisions. It is displayed as whole numbers — 1 to 5.

It was and continues to be the case that analysts employed by brokerage firms are overly optimistic with their recommendations. Due to the vested interests of their employers, these analysts issue more favorable valuations than their research would warrant, misleading investors far more often than helping them.

In contrast, the Zacks Rank is determined by earnings forecast revisions. And short-term stock price movements are strongly correlated with trends in earnings forecast revisions, according to empirical studies.

In addition, the various Zacks Rank classes are applied proportionately to all stocks for which brokerage analysts provide earnings estimates for the current year. In other words, this instrument always maintains a balance between its five ranks.

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.

Should you invest in TSM?

Looking at revisions to TSMC’s earnings forecast, the Zacks Consensus Estimate for the current year was unchanged over the past month at $4.97.

Analysts’ strong views on the company’s earnings outlook, as indicated by an unchanged consensus estimate, could be a legitimate reason for the stock to perform in line with the broader market 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 #3 (Hold) for TSMC. You can see the full list of today’s Zacks Rank #1 (Strong Buy) stocks here >>>>

Therefore, it might be wise to be a little cautious with the buy-equivalent ABR for TSMC.

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