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How to Evaluate Analyst Upgrades

Every week, I review the stocks that analysts upgrade and downgrade, to 1) see if any have been recently recommended in my Wall Street’s Best Investments or Wall Street’s Best Dividend Stocks newsletters, and 2) find out if any of them are in my personal portfolio or on my watch list.

Now, as I’ve said many times before, I don’t bet my future on analyst recommendations; they are only one criterion that I consider before buying or selling. And the reason for that is that analysts aren’t always as objective as we would like them to be. Many work for brokerage houses that have made money from underwriting the stocks they ‘independently’ research, or those same stocks may be held in a principal trading account or in accounts for the firm’s largest (and most profitable) customers, making the analyst’s opinion not as objective as most investors believe.

However, what often happens when one analyst changes his opinion on a stock is that other analysts do the same—especially in the widely held issues. Consequently, I find that the upgrades and downgrades are a good way to keep up with the street’s thinking about the stocks.

And like it or not—a stock’s price often fluctuates with the analyst’s opinion. And therein lies an opportunity for investors on the long and short sides—especially if you can take advantage of a gap between the first change in opinion and the subsequent volley of other analysts jumping on board.

But the change in opinion is just the first step in the analysis process. Think of it as a ‘tip’—the beginning of your research. The next step is divining why the opinion has changed, and whether it is meaningful.

Three New Analyst Upgrades—Should You Buy?

Let’s look at a few examples from this week’s analyst upgrades:

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All three of these companies have been recommended by contributors to our newsletters in recent months. In other words, they saw something interesting and attractive about these companies—before Wall Street jumped on the bandwagon.

First up, Goodyear Tire & Rubber (GT) was just upgraded by Credit Agricole. And last month, Standpoint Research changed their rating on the shares from a ‘hold’ to a ‘buy.’ Quarterly earnings, adjusted for non-recurring costs, were 93 cents per share, considerably higher than the consensus estimate of 74 cents per share. Revenue dropped, but it also beat forecasts. Shares rose $1.13 after the upgrade and earnings announcement.

Charles Carlson of The DRIP Investor, saw this coming and recommended the shares in Wall Street’s Best Investments a few months ago, saying “Goodyear is benefiting from a number of tailwinds. Strong U.S. auto sales are a plus. Also, the company’s commodity inputs, especially rubber, are favorably priced. Lower input costs have helped the firm’s profit margins expand sharply.”

Currently, five analysts have a ‘buy’ or ‘strong buy’ rating on GT.

SolarCity (SCTY) was upgraded by Raymond James, but the shares headed south after the company announced that although its loss in the fourth quarter—$2.37 per share—was less than estimated, the company said that its loss this quarter may be $2.65 a share, higher than the $2.49 loss previously thought. That sent the shares down $7.72 immediately following the announcement. And yet Raymond James upgraded the stock, although the brokerage firm did decrease its price target for the shares to $60 from $75. How can this be?

Perhaps Raymond James sees the same characteristics that Ryan Cole of Unconventional Wealth found attractive when he recently recommended the shares of SolarCity in Wall Street’s Best Investments. Here’s what Ryan had to say: “Every time I see oil prices slap solar stocks around, I rub my hands in glee. After all, we’re not in this for the short-term trade; we’re in Solar City for the long haul. And an emotional market that sells off solar stocks because of oil’s increasingly wild swings just gives us a better price point to enter. Not to mention, if solar stocks are pushed down enough, that will shake out Solar City’s competitors. And perhaps provide a few juicy takeover targets at rock-bottom prices. Solar City is the largest company in its field. It has plenty of contracts already on the book—and remember, Solar City’s largest costs come on initial installation. After that, it’s 20 years of near-straight profit.”

Thirteen analysts currently have a ‘buy’ on SCTY shares.

And lastly, let’s not forget about decent dividend payers. U.S. Bancorp (USB, 2.54% dividend yield) was upgraded by Wells Fargo, who cited the bank’s prudent management of its balance sheet, its disciplined approach to acquisitions, its efficiency, its fee-based profitable businesses, and its policy of sharing its profits with its shareholders. Normally, this ratings upgrade would have given the stock a nudge up, but an announcement that the Office of the Comptroller of the Currency fined the company $10 million for “shortcomings identified in the 2011 consent orders related to mortgage practices in a ‘timely fashion,’” sent the shares down by $0.36.

$10 million is a lot of money, but this fine amounts to a slap on the wrist for a bank that netted almost $6 billion last year, and it doesn’t put USB anywhere near the ‘worst offender’ category that other banks have joined, including Goldman Sachs, fined $5.1 billion; HSBC, $470 million; Bank of America, $17 billion; and Wells Fargo, $1.2 billion. And since USB was released from the consent order from last June that restricted some mortgage business, it’s back to “business as usual” for the bank.

The reasons for Wells Fargo’s upgrade are strikingly similar to what Chloe Lutts Jensen of Cabot Dividend Investor noted in her recent recommendation of USB, saying, “U.S. Bank came through the financial crisis in much better shape than most banks, thanks to good management and the high average credit quality of its loan portfolio. At the height of the financial crisis, the company’s non-performing loan ratio was half the industry average. In the seven years since, the bank has increased its Tier 1 capital reserves, maintained the high credit quality of its debt portfolio and grown both shareholder equity and EPS every year. While rising interest rates will be a major driver of income growth at USB over the next year-plus, the bank’s revenue model is an example of stability and reliability in the financial industry. Approximately half of total revenue is generated from fees for services like wealth management, payment processing and credit card servicing. Fee-based revenue is more reliable than income from investments, and largely insulated from market fluctuations.”

Twelve analysts currently rate USB a ‘buy’ or ‘strong buy.’

Get Ahead of the Wall Street Bandwagon

Each of these companies has a strong consensus rating of ‘buy.’ I like to see a number of analysts thinking the same way. And in each of these cases, the reasoning behind the recommendations is solid—all things that a fundamental analyst finds compelling, including industry growth characteristics, takeover possibilities, strong balance sheet, recurring revenues, market leadership, discounted valuations and attractive price targets.

So it’s smart to find out what the analysts are saying—just don’t rely on their recommendations as the complete step in your evaluation of a stock.

Here are some websites that will help you in your research:


Happy investing,

Nancy Zambell
Editor, Wall Street’s Best Investments and Wall Street’s Best Dividend Stocks

Nancy Zambell has spent 30 years educating and helping individual investors navigate the minefields of the financial industry. She has created and/or written numerous investment publications, including UnDiscovered Stocks, UnTapped Opportunities, and Nancy Zambell’s Buried Treasures under $10. Nancy has worked with for many years as an editor and interviewer for their on-site video studios.