What Analyst Ratings Really Mean

On the other hand, if there are one or two outliers that are different than the bulk of opinions, pay close attention to those opinions because they're likely to be insightful, original, creative and early. Analysts run in packs. If someone downgrades a stock because he suspects or identifies something that is negative or disturbing, it won't be long before others follow.

Do brokers who advise individual investors understand the code?

No, not much. They're almost like individual investors. In other words, they use the firm's research -- buy ratings, sell ratings, whatever -- to recommend stocks to clients. They use the firm's earnings estimates and the firm's strategist and economists and so forth, and it's the party line.

Brokers who have been around a long time at a firm have good sense for which analysts they can trust, which analysts have some credibility, which analysts are best at stock picking, and they will gradually focus on those analysts and disregard others.

I have had individuals ask me many times, how do I choose a broker? And I suggest that they get a broker who has been at the firm a long time and really knows the firm's research product and analysts because he knows whom he can trust. That's the best a broker can do.

You were onInstitutional Investormagazine's All-American Research Team for 19 straight years. How good is that list at identifying the truly good analysts?

The ones who are on the Institutional Investor team do tend be best in terms of knowing and understanding their industry sector and the companies they cover. That doesn't mean, though, they are particularly astute stock pickers.

They probably know their industry in more depth than anybody, and they are probably at least average in stock picking. If they were terrible and had lot of bad calls, they probably wouldn't be ranked. The list is a reasonably decent screen of the better analysts on Wall Street, but it is somewhat of a popularity kind or ranking -- or should I say a marketing kind of ranking.

I have always contended that if you are an incredibly astute analyst spending 100% of your time doing research and doing brilliant research, with no marketing at all, you probably wouldn't be ranked on the team. If you are not out there marketing your research, selling it, talking it up, communicating it, you're not going to have any impact.

The converse of that is, if you have a pretty mediocre average -- nothing special in terms of research quality and content -- but you're really good at marketing, you can make a fairly big impact. I always thought you could take a Hollywood-central-casting actor, give him some of the basics on how to do research, and he'd do pretty well.

In your book you advise investors to own a portfolio of no more than five to ten stocks. Is that enough to have true diversification?

I don't think an analyst on Wall Street whose job is to cover an industry sector in depth can really track 15 or 20 companies. Even with a team he can hardly do it. And for an individual it's impossible.

I encourage investors to wake up to the opportunity to listen to conference calls that happen every quarter. You can listen to them on the Internet; you can listen to them on the telephone; you can listen to them two or three weeks after they happen. If you own half a dozen stocks, you can listen to most of those conference calls every quarter for one hour. You're certainly not going to do that if you own 15 or 20 stocks.

Now I don't think all half-dozen stocks should be natural gas stocks, or all should be necessarily solar energy stocks. You need diversification within that half a dozen. But I own less than six stocks, and I pay a lot of attention to them. The consensus is to own a lot of stocks and diversify. If you're going to do that, own a stock market index.