Stock analysts' ratings may need interpretation

by Jack Lantis

for the Business Journal

If you're like many stock investors, you don't have time to keep up with all of the changes at the companies represented in your portfolio. A company's share price can be dramatically affected by many factors, including the economy, future profits, merger and acquisition possibilities and overall health of the company's industry.

As part of your decision-making process, you may rely on the recommendations made by professional stock analysts who monitor the companies on a daily basis and analyze a company's future growth prospects.

A better understanding of the ratings systems analysts use when making their company recommendations can go a long way in helping you get the most out of your portfolio. Here's a rundown of three of the most basic ratings used by many analysts:

Buy. The stock price is expected to exceed the growth rate from similar types of stocks or the overall stock market as measured by the Dow Jones industrial average or the Standard & Poor's 500 index.

However, a buy recommendation doesn't necessarily mean the stock is appropriate for your portfolio. As with all analysts' ratings, check to make sure that the stock fits with your investment objective, time period for investing and risk level. And remember that no one can always accurately predict a stock's future performance. Recommendations are just that recommendations.

Sell. The stock price is expected to substantially underperform the overall market, which can be attributed to a number of factors, including an inexplicably high share price or a company's deteriorating fundamentals. Analysts issue sell ratings sparingly, so they should be taken seriously.

But be careful not to panic when a sell recommendation is made. If you're a long-term investor perhaps you're saving for your retirement in 20 years you may want to keep the stock if you believe that the company can make a comeback if given enough time. However, be sure to consult your financial professional before hanging onto a stock with a sell rating.

Hold. The stock is expected to perform in line with the overall stock market or stock issued by similar types of companies, also known as a peer group. No action is recommended in this situation.

In addition to the ratings mentioned above, analysts also issue other ratings that assess the varying degrees of performance they expect from a company over a particular time period. Remember, not all analysts' ratings mean the same thing even if the terminology used for the ratings is the same. Become familiar with the ratings definitions used by a particular analyst or firm.

Most experts agree that the best strategy is to invest for the long term, typically a minimum of three to five years. Long-term investors need to practice patience and be careful not to overreact when an analyst's recommendation changes on an individual stock. A well-diversified portfolio (at least 15 to 20 different stocks) can help reduce the impact of any one stock's lagging performance in the portfolio.

P.S. Check out corporate bonds. Meanwhile, with enthusiasm for stocks and bonds issued by U.S. companies dampened by the cloud hanging over the world's financial markets and economic uncertainties at home, there are now bargain prices on some company stocks, as well as attractive opportunities for corporate bonds.

Some financial experts are predicting a comeback in these fixed-income securities. (Of course, there can be no assurance that financial experts will be right; the decision to invest is ultimately yours.)

When you purchase a corporate bond, you are actually making a loan to the issuer the corporation which promises to pay you a specified interest rate and to return the face value of the bond at maturity.

Usually, the more risk associated with the corporate issuer, the higher the interest rate it must pay on its bonds to sell them. In addition, the longer the maturity of a bond, generally, the higher the interest rate it will pay. Corporate bonds are generally available in $1,000 increments and pay interest twice a year.

Before purchasing a corporate bond, you should be aware of the bond's rating. The two most recognized independent rating companies, Moody's and Standard & Poor's, rate bonds based on the issuer's credit rating and ability to repay, even under adverse economic conditions.

Bonds rates BAA or higher by Moody's or BBB or higher by Standard & Poor's are considered investment-grade bonds, meaning their risk level is appropriate for most investors.

One indication that corporate bonds are good buy opportunities is when the gap widens between yields on corporate bonds and Treasury bonds. This scenario has occurred recently as investors spooked by the declining stock market have sought safety in Treasuries, boosting demand for these securities and resulting in higher prices and lower yields.

On the other hand, concerns over future corporate profits have had just the opposite effect on corporate bonds, whose prices have remained steady or fallen, keeping yields above that of Treasuries.

In fact, experts say that corporate bonds are as attractively priced as they have been since 1990 and 1991.

For example, high-quality, double-A-rated, 10-year corporate bonds of industrial companies recently yielded about 4.91 percent roughly 69 one-hundredths of a percentage point more than comparable benchmark Treasuries.

But remember, to receive the relatively higher yields offered by corporate bonds, you have to hold these bonds to maturity. If you sell the bond prior to maturity, it could be worth more or less than you paid for it.

Additionally, while government bonds are guaranteed as to the timely payment of principal and interest by the U.S. government, corporate bonds have no such guarantee.

If you're considering buying corporate bonds, you should stick with high-quality issues with little or no exposure to Asia and emerging markets. Avoid bonds issued by companies whose businesses are cyclical and may be out of favor in the current economic environment.

Your financial consultant can help you identify corporate bond opportunities suited to your particular situation.

(Jack Lantis is an investment broker with A.G. Edwards & Sons Inc. in Springfield.)

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