Regularly Review Recommendations to Prevent Stock Calls from Rotting on the Vine
If you planted a garden in the spring, you wouldn’t wait until the fall to see if you had any ripe vegetables. And yet the equivalent occurs all too often when analysts don’t make the effort to regularly review their recommendations. When I was an analyst, one of my favorite buy-side clients was known for shouting at sell-side analysts “I don’t need help knowing when to buy a stock, but when to sell.” He was right in that the sell-side (and buy-side) are overly focused on when to get into a stock with relatively minimal emphasis on when to get out.
It’s not that analysts are intentionally neglecting this important step, but they get distracted in searching for the next “buy” rather than tending to what’s ripening in their garden. The scenario goes something like this…the analyst upgrades a stock and due to the personal pride attached to his thesis, over time he loses sight of the recommendation’s risk/return trade-off relative to other opportunities within his universe. It’s such a common problem, the term “round trip” is used among some analyst circles when describing the great stock call that goes up, only to then return to its original price, all the while being rated a “buy.”
Too often analysts get lost looking for the next killer stock call only to neglect their current recommendations
Given the complexity of stock-picking, I built the TIER™ framework, all in an effort bring more rigor to the process. The “R” of TIER™ is for “Review performance and thesis” which is the focus of the table below. By focusing on these steps, analysts can ensure they’re always recommending the stocks with the best risk/return trade-off within their universe.
|Dynamically rank and review your stocks regularly
|Review your comparison ("comp") table regularly (i.e. daily or a few times each week) to ensure you’re always recommending the stocks with the best risk/return proposition. To provide the best analysis, the table should:
|Be open to selling poor performers and buying stocks you haven’t liked in the past
|This is an important part of the investment process to ensure you’re avoiding the mind traps I've identified as "Fear of failure" which include:
|Review original documentation
|Re-think recommendation if thesis wanes
|If new, reliable information comes to light that derails the basis of the stock call, do an about-face on the rating as quickly as possible. It will be painful, but not as bad as living with a stock thesis that's never going to play out.
|Re-think recommendation if catalyst is ineffective
|If the key catalyst for the stock recommendation occurs and the stock doesn't move to the price target, strongly re-think the recommendation and avoid the temptation to find another catalyst to justify the recommendation.
|Review unbiased comparisons
|Reduce sunk-cost, loss-aversion and other biases by periodically (once a month or quarter):
|Avoid placing blame or denying responsibility
|When a stock call goes poorly, avoid placing blame on others for a bad stock call, or saying, “The surprise couldn’t have been foreseen.” Instead, ask yourself these questions:
In addition to the steps above, here are some philosophical considerations that help in the area of regularly reviewing recommendations:
- Don’t mistake good stock picking with a bull market: Always evaluate performance relative to a similar basket of stocks. (This also holds true when evaluating company management’s comments about its stock performance.)
- Mistakes can be valuable lessons: Stock calls that go bad can have some salvage value, as long as the shortcoming is analyzed and internalized to avoid a similar bad call in the future
- Automation will lead to more frequent reviews: Automate your comp table by having it draw key data directly from market data providers (and possibly from your financial models). This will reduce the laborious manual entry process which increases the frequency that this valuable table is reviewed.
- Accept that past losses shouldn’t impact future decisions
Using my garden analogy above, make sure to check your stock recommendations regularly so you can spot if they’re ripe or, potentially rotting on the vine. It takes some extra work, but it’s critical to ensure you’re getting out of your recommendations at the optimal time.
This Best Practices Bulletin™ targets #3. Make Accurate Stock Recommendations of GAMMA PI™, within our Pathway to Success Framework. Let me know if this Best Practice Bulletin™ helps and how I can improve upon it. If you’re interested in exploring this topic further, AnalystSolutions provides equity research training with a specialized workshop to help Master the Stock Call Techniques of Highly Experienced Analysts
Improve you or your team’s stock picking and communication skills with our equity research analyst training tools, which includes workshops such as the one above, as well as our GAMMA PI™ assessment and one-on-one coaching. Also, consider ordering the book that inspired the founding of AnalystSolutions and the Best Practices Bulletin: Best Practices for Equity Research Analysts.
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©AnalystSolutions LLP All rights reserved. James J. Valentine, CFA is author of Best Practices for Equity Research Analysts, founder of AnalystSolutions and was a top-ranked equity research analyst for ten consecutive years