A study narrowly tailored to pick up stock trades immediately following changes in stock analysts views seems to demonstrate that they have almost no effect.
The Financial Times reports that Oya Altinkiliç of the University of Pittsburgh and Robert Hansen of Tulane University looked at trades in the 20 minutes before and after the issuance of a new recommendation and found that the effect was just 0.03 per cent. Interestingly, the minimal effect was the same whether the change was positive or negative.
This confounds previous academic studies that found analyst changes could move a stock’s price by up to 4 per cent. Those studies looked at longer timeframes, which the authors of the new study suggest opened them up to much to being effected by outside news.
The Financial Times thinks this could fuel the debate over the role of stock research. The authors of the study are certainly down on stock analysis. They point out that 80 per cent of analyst changes are made after company news has been disclosed. “Analysts’ revisions are typically information-free,” the study concludes.
“Analysts’ recommendations don’t add much value and investors know it,” Hansen says.
We’re not sure this is as big of a problem for analysts as the study’s authors and the Financial Times suggests. The fact that 80% of analysts recommendations are piggy-backing on the news means that 20% are not. What’s more, piggy-backing on the news might be far more useful than the authors suggest. Investors may not always be able to quickly translate news into how that will effect a stock. Why assume this has no value?
It may be that stock analysts don’t change investment behaviour because of their analysis, but this doesn’t mean they aren’t adding information. The market may just be unduly discounting their analysis.
The procedure of only looking at changes in prices over an extremely short term assumes that stock analysis should move markets rather than predict market movements. By excluding exogenous events that occur after the issuance of a new recommendation, the authors may be excluding the very things the analysts are saying will move the stock. Thus the study may suggest that we should be paying more attention to analysts rather than less.
But there is at least one very intriguing reading of the study having to do with insider trading. If analysts stock recommendations don’t move stock, should people who trade stock on advance knowledge of the recommendations be found guilty of insider trading? The theory of insider trading depends on the idea that investors are harmed in some way by someone gaining an advantage from non-public knowledge. This study says there is no real advantage to trading on non-public knowledge of analysts views, which suggests these insider traders should be exonerated.
To take a recent example, the SEC recently accused a ring of 8 people, three hedge funds, two broker dealers and a day trading firm of trading ahead of UBS stock calls. What’s the harm in doing this if the stock recommendations have no effect? If I were one of the accused, I’d be ordering my lawyer to file a motion for dismissal stat.
Before we leave off this, we’ll bring up a more sinister possibility. It could be that the reason stocks don’t move in the 40 minutes surrounding an analysts recommendation is because pervasive insider trading has already moved the stock in line with the analysts view. In this case, stock analysis would be moving stock but such analysis would be completely worthless to the honest investor who receives the recommendations too late to profit from it.