With penny stocks, going against analyst recommendations usually pays off.
Despite living and breathing the stock market, reading financial reports, and crunching numbers, I hate doing my own taxes. I was in signing my tax forms recently and my accountant asked me what I did.
He said it’s too bad I’m into penny stocks (under $5) because there just isn’t much information on them. Not only that…few if any analysts follow or recommend them. I shrewdly pointed out that there are hundreds of great penny stocks with excellent fundamentals and operations.
The information is out there…you just have to be proactive and find it yourself. And perhaps not rest on the overpaid laurels of some analyst recommendation. Though really, how many analysts cover penny stocks?
Analysts can’t recommend most penny stocks because their market caps are too small. Brokers won’t tell you about penny stocks because they generally tend to be quite volatile. Unlike mid and large caps, I suppose.
If a Wall Street analyst did put a ‘buy’ rating on a penny stock, chances are its share price would sky rocket. Good for those who got in earlier – but not so great for those that listened to the analyst. Penny stocks can be thinly traded, meaning you may not be able to liquidate as easily as you might like to.
Turns out analyst recommendations may not be such a hot thing after all.
In spite of all their hard hours of work sipping Pellegrino and dotting their i’s with Mont Blanc pens, analysts are in no better position than you and me when it comes to rising stars and dogs.
It turns out doing the opposite of an analyst recommendation is often a better strategy than following their advice. Or so a recent survey from Thomson Reuters suggests.
The group examined the performance of stocks in the S&P 400 MidCap Index, based on analyst recommendations. Surprisingly…or not, the stocks with the highest ratings tended to fare the worst.
The study covered a 13-year period, from March 31, 1994 to December 31, 2007. Over that time, a group of the 80 lowest-rated stocks posted an average annual return of 14.35%. The top 80 stocks returned 10.96%.
The study also followed other indexes with similar results. On the Dow Jones Industrial Average, the 10 stocks with the lowest analyst ratings posted an average annual gain of 13.87%. Over the same period, the Dow returned 12.17% and the S&P 500 11.04%.
When it came to the S&P 100, “Poorly recommended stocks tend to do much better than highly recommended stocks.” While, “highly recommended stocks…underperformed substantially.”
One article reviewing the survey noted that the “stocks that are hated on Wall Street are often pushed to unreasonably low levels, setting them up for a rebound.” In bearish markets, like the one we’re currently in, highly rated stocks tend to lag the market. “This may be due to the fact that during bull markets, analysts and investors favor growth stocks that do well in precisely that sort of environment.”
If you’re an analyst and looking to boost your recommended percentage growth – might I suggest you look at Zambia’s Stock Market. Zambia’s Lusaka Stock Exchange has only 16 listed companies and is growing by more than 40% and racked up an overall market return of 102% in 2007.
They also have their own SEC, and listed companies have to have a history of making profits for at least three years.
What are penny stock investors to do? Maybe be thankful that there isn’t a boiler room full of penny stock analysts. Doing your due diligence and resting on your own laurels isn’t such a bad idea.
