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Investing in stocks on the basis of brokerage recommendations

Equity Investing

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Equity Investing article in Advisorkhoj - Investing in stocks on the basis of brokerage recommendations

Investors, who have trading accounts with equity broking firms, receive text message or emails from their brokers every day, recommending which stocks to buy or sell. When they tune into a business news channel on the TV, they see market experts giving buy or sell calls every few minutes. Calls from different brokerages and experts are sometimes contradictory. How will the retail investors take a decision on which stock to buy or sell?

Let us take the example of Tata Steel. In February Kotak Securities had a buy call on Tata Steel with a price target of 425. On the same day ICICI Securities had a hold call with a target of 390. In the same week Motilal Oswal and Anand Rathi had sell calls on Tata Steel. Come March, Edelweiss had a buy call on Tata Steel with a price target of 440, but in the same week Angel Broking had a sell call. It is very natural for the retail investor to be confused. What will the investor do? Either he decides to play safe and does not enter the market at all. Or he follows his broker’s recommendation and ignores others. Depending on whether his broker had called correctly or not, the investor makes a profit or loss. Let us now look at how the stock price of Tata Steel moved in the last one month.

The vertical lines represent the intraday high (top point of the line) and low (bottom point of the line) and the red line represents the closing price. If the investor had acted on the buy call (Kotak) in February and bought the share at Rs 370 – 380, on close of trade today (Mar 19) he would have a book loss of Rs 30 – 40. If the investor had acted on the sell call (Motilal Oswal or Anand Rathi) and sold at Rs 370 – 380 and bought it back at Rs 340 on Mar 11 – 12 based on the Edelweiss call, he would have made a profit of Rs 40 – 50. But it would not be easy to make the decision to buy at Rs 340 because Angel Broking had a sell call. The point we are trying to illustrate here is that the financial outcome for the investor or trader depends on three things, the time horizon of the investor, knowing which level to buy and which level to sell. Here we must stress that investing in stock markets is risky. It requires a level of expertise, and requires the investor or trader to devote sufficient time and effort to monitor how his or her investment is doing and how the market is trending. As such, mutual funds are better option for average investors who do not have that level of expertise or cannot devote sufficient time.

Retail investor who invest or trade directly in the stock market should note that, no brokerage research can be 100% right all the time. Investors should exercise caution and try to come up with a consistent methodology in deciding which recommendations to act on. In this article we will try to illustrate with examples. Readers should note that we are NOT making any stock recommendations. We are only analyzing the recommendations made by the leading broking houses and the stock price movement in the last 3 – 4 months.

There are a few important considerations for investors, when making a buy or a sell decision.

  • What is their investment horizon? If the investment horizon is sufficiently long, then they should not bother about buy or sell ratings issued by the brokerage houses. Investors should remain invested, unless there are big developments affecting the company or sector

  • Investors should understand the timeframe of the brokerage recommendations. Usually, brokerages give buy, hold and sell or outperform, equal-weight and underperform ratings, and a target price for 6-18 months. Investors should make their decisions accordingly

  • Investors should understand the methodology behind the recommendations. They should understand the difference between technical and fundamental analysis. Usually technical analysis, which is based on historical prices and pattern formation, is more effective in the short term, while fundamental analysis which is based on economic and financial analysis of the company and sector is more relevant in the long term. Investors should be convinced with the logic behind the recommendation and then act on it.

  • Investors should take into account multiple opinions from different brokerages and experts before making a decision. As stated earlier, no one is right 100% of the time. However, if a number of brokerages and experts have the same opinion then it gives the investor the confidence that the decision may be right

  • Finally, investors should monitor the actual performance of the stock price versus the brokerage recommendation

Let us examine with the help of a few examples, recommendations made by the brokerages in the last 3 – 4 months and the stock price movement in the same period. Here we have considered only delivery (cash) based calls (not F&O).

Larsen & Toubro

As you can see that there are mostly buy or hold calls in L&T in the last four months. This indicates that there is bullishness amongst the brokerages about this stock. Also note that the price targets for the more recent buy calls are higher. Clearly brokerages believe there is momentum in this stock. Let us see how the L&T share price has moved in the last four months.

Based on the share price movement in the last 4 months, the bullishness was justified. Even the sell call from Kotak was justified, since the share price fell from 1,030 or so to about 950, only to rise again. We have to wait and see when and if L&T can touch the price targets given by Edelweiss and LKP

Reliance Industries

Again there are mostly buy calls in Reliance the last four months. But Edelweiss and Prabhudas Liladhar have different price targets for this stock, showing lack of consensus of where the stock is headed. LKP had a sell rating on Reliance. Let us see how the price has moved in the last 4 months.

Reliance share price was under pressure in January - February, and has seen recovery recently. The share is trading at around 900. None of the price targets in the buy calls have been met so far. However, if the investor initiated a short on LKP’s recommendation in the end of February, he would be sitting on losses.

Mahindra and Mahindra

There are mostly buy recommendations for Mahindra and Mahindra. Also note that the price targets for the more recent buy calls are higher. Clearly brokerages believe there is momentum in this stock. Let us see how the price has moved in the last four months.

Based on the share price movement in the last 4 months the bullishness was justified. Price targets of Motilal Oswal, Anand Rathi and IIFL were met. We have to wait and see when and if Mahindra and Mahindra can touch the price targets given by ICICI Direct and KR Choksey.

ICICI Bank

There are three buy calls and 2 sell calls in ICICI Bank, making this a tricky decision. We know that ICICI is a high beta stock. Let us see how the price has moved in the last four months.

The buy calls were all justified, since all the price targets have been met, either on a closing basis or an intraday basis. Aditya Birla Money and IIFL have sell calls. There is an RBI policy announcement in about two weeks. It may be a negative impact on ICICI Bank share price. Or there may be a positive impact. We have to wait and see.

Infosys

There are mostly buy or hold recommendations for Infosys. The price targets are in the range of 3730 to 4000. Brokerages are bullish on Infosys. Even recommendation issued by Prabhudas Liladhar last week had a buy rating, despite the indications by Infosys that Q4 revenues might be lower than expected and sharp drop in share price. Let us see how the Infosys price has moved in the last four months.

The price targets of Angel Broking and ICICI Direct have been met. The share price has seen a sharp downturn from last week, after Infosys’ lower Q4 revenue guidance. So it seems First Call, Edelweiss and Prabhudas Liladhar price targets are some distance away for Infosys as of now. We have to wait and see if Infosys can touch these price targets.

Conclusion

In summary, investing in equity markets is complex. Investors need to invest considerable amount of time and effort. They need to educate themselves about the market and follow it closely. They need to keep abreast with what is happening in the economy and sectors where they are invested. Brokerage recommendations are useful in making investment decisions, provided investors use them wisely. Investors need to develop a pragmatic methodology to decide which recommendations they can act upon. The examples above can help the investors form guiding principles as they look at multiple brokerage recommendations on a stock.

( Mutual Fund investments are subject to market risks, read all scheme related documents carefully.)

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Dwaipayan Bose

An alumnus of IIM Ahmedabad, Dwaipayan is a Finance and Consulting professional, with 13 years of management experience, mostly in MNCs like American Express and Ameriprise Financial, both in India and the US. In his last role, he was the Chief Financial Officer of American Express Global Business Services in India. His key interests are building best in class organizations, corporate governance and talent development

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