When deciding whether to buy, sell, or hold a stock, investors often rely on analyst recommendations. Media reports about rating changes by these brokerage-firm-employed (or sell-side) analysts often influence a stock's price, but are they really important?
Let's take a look at what these Wall Street heavyweights have to say about Zscaler (ZS) before we discuss the reliability of brokerage recommendations and how to use them to your advantage.
Zscaler currently has an average brokerage recommendation (ABR) of 1.67, on a scale of 1 to 5 (Strong Buy to Strong Sell), calculated based on the actual recommendations (Buy, Hold, Sell, etc.) made by 39 brokerage firms. An ABR of 1.67 approximates between Strong Buy and Buy.
Of the 39 recommendations that derive the current ABR, 25 are Strong Buy and two are Buy. Strong Buy and Buy respectively account for 64.1% and 5.1% of all recommendations.
Brokerage Recommendation Trends for ZS
Check price target & stock forecast for Zscaler here>>>
While the ABR calls for buying Zscaler, it may not be wise to make an investment decision solely based on this information. Several studies have shown limited to no success of brokerage recommendations in guiding investors to pick stocks with the best price increase potential.
Are you wondering why? The vested interest of brokerage firms in a stock they cover often results in a strong positive bias of their analysts in rating it. Our research shows that for every "Strong Sell" recommendation, brokerage firms assign five "Strong Buy" recommendations.
This means that the interests of these institutions are not always aligned with those of retail investors, giving little insight into the direction of a stock's future price movement. It would therefore be best to use this information to validate your own analysis or a tool that has proven to be highly effective at predicting stock price movements.
With an impressive externally audited track record, our proprietary stock rating tool, the Zacks Rank, which classifies stocks into five groups, ranging from Zacks Rank #1 (Strong Buy) to Zacks Rank #5 (Strong Sell), is a reliable indicator of a stock's near -term price performance. So, validating the Zacks Rank with ABR could go a long way in making a profitable investment decision.
Zacks Rank Should Not Be Confused With ABR
In spite of the fact that Zacks Rank and ABR both appear on a scale from 1 to 5, they are two completely different measures.
The ABR is calculated solely based on brokerage recommendations and is typically displayed with decimals (example: 1.28). In contrast, the Zacks Rank is a quantitative model allowing investors to harness the power of earnings estimate revisions. It is displayed in whole numbers -- 1 to 5.
It has been and continues to be the case that analysts employed by brokerage firms are overly optimistic with their recommendations. Because of their employers' vested interests, these analysts issue more favorable ratings than their research would support, misguiding investors far more often than helping them.
On the other hand, earnings estimate revisions are at the core of the Zacks Rank. And empirical research shows a strong correlation between trends in earnings estimate revisions and near-term stock price movements.
Furthermore, the different grades of the Zacks Rank are applied proportionately across all stocks for which brokerage analysts provide earnings estimates for the current year. In other words, at all times, this tool maintains a balance among the five ranks it assigns.
There is also a key difference between the ABR and Zacks Rank when it comes to freshness. When you look at the ABR, it may not be up-to-date. Nonetheless, since brokerage analysts constantly revise their earnings estimates to reflect changing business trends, and their actions get reflected in the Zacks Rank quickly enough, it is always timely in predicting future stock prices.
Is ZS a Good Investment?
Looking at the earnings estimate revisions for Zscaler, the Zacks Consensus Estimate for the current year has increased 75.7% over the past month to $2.99.
Analysts' growing optimism over the company's earnings prospects, as indicated by strong agreement among them in revising EPS estimates higher, could be a legitimate reason for the stock to soar in the near term.
The size of the recent change in the consensus estimate, along with three other factors related to earnings estimates, has resulted in a Zacks Rank #2 (Buy) for Zscaler. You can see the complete list of today's Zacks Rank #1 (Strong Buy) stocks here >>>>
Therefore, the Buy-equivalent ABR for Zscaler may serve as a useful guide for investors.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
