gold investing

A Guide to Analyst Recommendations

Aug. 18, 2014 04:05PM PST

It is helpful for gold investors to understand analyst recommendations in order to make good investment decisions about gold explorers, producers and other types of mining companies.

Mining and exploration companies make up a significant part of the resource sector. And while there are projects focused on a wide range of base and precious metals, investors are no doubt aware that a substantial portion of miners choose to focus on gold. 

That leaves gold bugs spoiled for choice when it comes to investing in mining companies. In some ways that’s good, but it can be difficult to wade through all of the information available while also keeping an eye on the gold market overall.

Analyst recommendations can help investors gain a fuller picture of the state of broad or specific markets and can inform their next steps; accordingly, it is helpful for gold investors to understand analyst recommendations.

However, such recommendations usually take the form of a single word, according to the Financial Industry Regulatory Authority (FINRA). They are based on serious, in-depth research, and have a huge impact on the flow of capital. They are not useless, but they do require a certain amount of understanding if they are to be used to create true value.

What do analysts do?

Before going over how to use analyst recommendations, it’s useful to learn what they do. According to the US Bureau of Labor Statistics, analysts recommend individual investments and portfolios by evaluating a set of current and historical data on the investments in question. They also study the economy and business trends closely, ensuring that they understand the broader shape of the market.

Furthermore, analysts devote quite a lot of time to examining a company’s financial statements. They do that to determine its value and performance, and often meet with company officials to get further insight into what they have learned. Finally, analysts prepare written reports and make recommendations to investors. Some analysts will also meet with investors to explain their recommendations more fully.

It is important to note that analysts have loyalties and biases just as much as anyone else does. FINRA states that analysts are often employed by private investors or other firms that have a financial interest in the analyst’s recommendations. Some companies stand to benefit from currents in the market, and the analysts who work for them do as well. Some conflicts of interest include investment banking relationships, compensation based on the firm’s profits, commission for brokerage and ownership interests in a company itself. All of those are reasons to take analyst recommendations with a grain of salt.

Investors should also know that the rules of the New York Stock Exchange and FINRA require analysts to disclose certain conflicts of interest when they are recommending the purchase or sale of a security. NYSE and FINRA rules now bar analysts from promising firms a favorable rating in exchange for investment banking business. A firm that is managing or co-managing a securities offering can’t issue a report on that company within 40 days after an initial public offering. Further, research analysts can’t be supervised by the investment banking department of their firm.

There are other practices that have been barred as well, but investors must keep in mind these are only the rules of the NYSE and FINRA, and are not considered to be law. Still, analyst recommendations can still be quite useful.

What are analyst recommendations?

As discussed above, analyst recommendations tend to be one-word summaries of extensive research. Investors should note that different firms use different words, so direct comparisons between the opinions of different analysts are difficult to make. Even firms that give “consensus” ratings use their own scales, sometimes numerical. Some firms’ highest recommendation is “buy,” while others will use “strong buy” for this purpose and use “buy” for the second-highest tier of recommendation.

Others barely use the word buy at all, according to FINRA, instead preferring to mark equities or portfolios as on a “recommended list.” MarketWatch provides a list of the terms that different firms use for investors who want to understand them more fully.

FINRA notes that it isn’t wise to make a decision based solely on an analyst’s recommendation. However, the authority states that recommendations can give a picture of how experts in the market believe a stock or portfolio is likely to perform in the future. Investors who don’t have the funds to purchase vast financial reports, often offered for sale by firms, may value analyst recommendations as a quick way to gain insight into the market and its anticipated future.

How can investors use analyst recommendations?

For investors, the wisest way to use analyst recommendations is to consider them just one piece of their research.

Researching a prospective investment on one’s own is a smart idea. Important information about any publicly traded company is available from the exchange on which it is traded in most cases. Investors who have difficulty understanding precisely what these documents mean can look for other sources of information, such as news articles and press releases, that may give more insight into the the company or portfolio.

It’s also a good idea to look at as many consensus recommendations as possible. These are often available in publications geared toward investors in particular markets and can measure the opinions of analysts whose predictions are outliers in the investing conversation. Very motivated investors can even look at a particular analyst’s track record in order to determine whether their history seems reasonably good. Of course, it’s very unlikely that an analyst will always be right. However, there are certainly different degrees of skill within in the profession.

Furthermore, it is necessary to have an idea of what is an acceptable investment. Investors with a high risk tolerance and a long time horizon have very different needs than those with a short time horizon and a low tolerance for risk, for example.

Finally, investors might choose to consider analyst recommendations as flags that point them towards further research in a company or a portfolio. Using recommendations in this way is a method that can allow investors to stay caught up on the latest trends and currents in the market — and on companies they may not be familiar with yet.

The upshot

Overall, analyst recommendations can be useful, but diligent investors will look beyond the one-word answer. Reading reports and ensuring that careful research follows an interesting recommendation will no doubt help investors to feel confident that they are making good investment decisions.

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