4 Out of 5 Analysts Agree — And That's a Bad Thing

The herd is an unsafe place.

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TV producers love nothing more than a big, bold prediction.

"Short the banks."

"This stock will DOUBLE."

"Sell the Lego, empty mum's piggy bank, and back up the truck for gold!"

Big calls make for great television. So does confidence — no one likes to take investing advice from someone who hedges their bets, even though that's the reasonable thing to do. As investing great Peter Lynch said, even the best stock pickers aren't likely to be right more than 60% of the time.

It gets better — for pundits. If you're right about one of your massive contrarian calls you can make a career out of victory-lapping. Economist Nouriel "Dr. Doom" Roubini, who is credited with calling the U.S. housing collapse, is still a regular on the talking head and lecture circuit despite having been repeatedly wrong about the ensuing economic recovery over the past six years.

Roubini isn't the only economist given a pass. 100% of the economists surveyed by the Australian Financial Review in late November predicted the next interest rate movement would be up. Just two months later, the RBA cut interest rates!

The trouble is that these analysts are rarely called out for bad calls. Personally, I've made hundreds of media appearances over the years and have been reminded of my previous calls only a handful of times, for better and worse.

So, with no accountability and knowing that making big, bold calls are likely to get you invited back onto a show, is it any wonder pundits always go guns blazing?

Sadly, the viewing public, who doesn't grasp the pundit's misaligned incentives, is the one who pays the piper.

Safety with the Herd

But here's where things get quirky. On the other end of the spectrum, professional analysts, advisors, and economists — the likes of those who provide price targets, half-year earnings estimates, and like to stuff their reports with as many big words as possible — have very little incentive to stick their necks out and make even reasoned, considered contrarian calls. There's safety with the herd and a single bad call can mean the difference between a big bonus and no bonus. Or, worse, keeping one's job.

A recent article — "Top analysts pass judgment on Telstra" — unknowingly highlighted this group-think approach to sell-side research. The writer queried five "top" analysts for their ratings on the shares and their price targets.

You'd think it takes a strong, contrarian viewpoint to crack such a list, but no. Only one of the five analysts rated Telstra Corporation Ltd. (ASX:TLS) a "Sell." Of the other four, the average price target was $5.56 — only 5% away from the then-current price of $5.29. Talk about sticking with the herd!

I think Telstra is a great business, by the way, and I'd love to add shares to Pro at the right price. But that's not the point.

The moral of the story is to question the incentives of anyone giving you financial advice. For pundits on TV, never forget that they have an incentive to make big, hairy calls. And analysts issuing the kinds of price targets and ratings you read about in the news, always remember they have little reason to stray from the herd.

And what about us here at The Motley Fool? Great question! Our business hinges on our success as investors. For starters, we're putting $1 million of our company's own money behind our investments at Pro — investments we only make after you've had two full days to "front run" our recommendation and buy shares for yourself.

As icing on the cake, my boss, Bruce Jackson, is even investing $250,000 of his own money behind our investments at Pro.

And what about me? Beyond the pressure of managing your boss' and company's savings, my largest personal investment is my stake in The Motley Fool. I have a lot riding on our team's ability to deliver you winning, accessible advice.

More importantly, my reputation is constantly at stake. My name is attached to every recommendation at Pro and members will forever be able to track our trades and rationales. Such transparency, especially in the internet age, will keep a man on his toes.

So remember those incentives, Fools, and make sure you're aligned with the folks whose incentives are aligned with your own.

Joe Magyer is the portfolio manager of Motley Fool Pro. does not own any of the companies mentioned in this article. The Motley Fool has a disclosure policy.

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