A Fundamental Imbalance on Wall Street
Investors often face a dilemma when analyzing ratings upgrades and downgrades on Wall Street. For instance, how should one interpret the recent upgrade of DoorDash stock alongside the downgrades of Dropbox and PayPal Holdings? While the downgrades may be seen as a warning for Dropbox (DBX) and PayPal Holdings (PYPL), the significance of DoorDash's (DASH) upgrade is less clear. This is because Wall Street downgrades are relatively uncommon and, therefore, carry more weight than upgrades.
According to FactSet, a mere 5.6% of current Wall Street analyst ratings for S&P 500 (SPX) companies fall under the "sell" category. In contrast, approximately 54.4% of these ratings place companies in the "buy" category. The accompanying chart provides a visual representation of this unequal distribution.
However, it would be a mistake to assume that the overwhelming number of "buy" ratings compared to "sells" indicates a bullish market sentiment. As observed in the chart, the current percentages are consistent with the five-year average, suggesting that this imbalance is not an anomaly.
Efforts were made in 2002 by the National Association of Securities Dealers (NASD) when they introduced Rule 2711. This rule mandated firms to disclose the proportion of their stock ratings categorized as buy, hold, or sell. The intent was to encourage firms to adopt a more balanced approach and mitigate the exaggerated bullishness displayed in their ratings. While NASD Rule 2711 was replaced by FINRA rule 2241 in 2019, both rules maintain the disclosure requirement. The question remains whether these regulations have successfully addressed the fundamental imbalance persisting on Wall Street.
The Changing Landscape of Wall Street Analyst Ratings
Wall Street analysts have always had a significant impact on the stock market. But in recent years, their influence seems to be waning. Prior to the implementation of Rule 2711, which aimed to increase transparency, analysts' "buy" ratings for S&P 500 companies ranged from 60% to 80%, according to FactSet data. However, after the rule came into effect, this range shifted downward by about 15 percentage points. On the other hand, the range of "sell" ratings increased slightly by three percentage points. Despite this adjustment, there were still significantly more "buys" than "sells."
Interestingly, these changes may have inadvertently diminished the value of a Wall Street "buy" rating. A study conducted by researchers at South Korea's Yonsei University found that since 2002, stocks upgraded by Wall Street analysts have not, on average, outperformed the broader stock market. This is a departure from the period prior to 2002 when they did yield higher returns.
Conversely, downgraded stocks have consistently underperformed, confirming the importance of paying attention to Wall Street analysts' ratings. However, investors should give more weight to downgrades rather than upgrades.
In light of this, we present a list (compiled by FactSet) of S&P 500 stocks with a high percentage of analyst ratings categorized as "sell" or "underweight." These 11 stocks have a percentage of at least 30%, far exceeding the overall 5.6% across all S&P 500 companies.
Remember, when considering investment decisions, it's wise to take into account multiple sources of information and conduct thorough research to make informed choices.
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