Understanding Broker Recommendations

The Motley FoolI wonder how many of you get recommendations from your brokers. I have been receiving them from various brokers for years. Nevertheless they still remain a source of mystery to me.

I can understand it when a broker talks about “buy” and “sell”. To me, a “buy” means the shares probably look cheap, so its probably time to climb on board. The opposite of a “buy” is a “sell”. That is quite self-explanatory too. It probably means the shares may look overvalued, so it may be a good idea to get rid of them if you don’t want to have them in your portfolio anymore.

At a push I can even understand a “hold” recommendation. It means hang on to the shares if you already own some. But if you don’t already own any, then you may want to consider sitting on your hands for the time being. It probably means something might happen to the shares but it is not entirely clear which direction the shares may move.

So far, so good. However, my eyes glaze over as far as other broker-inspired hubbub is concerned.

Thing is, if you haven’t already noticed, brokers have a tendency to speak in mysterious euphemisms. For instance, what does it mean when a broker recommends a firm hold? Clearly it is stronger than a weak hold. But isn’t a hold just a hold? And how does a “hold” differ from “neutral”, which is another popular broker recommendation?

Another fashionable reference by brokers is “equal weight”, which I assume might be similar to a “hold” or “neutral”. That said, it does feel less forceful than a “firm hold” but has slightly more conviction than a “weak hold”.

But what if you don’t already have any of those shares? It probably means that you weren’t paying attention to the broker’s earlier recommendation to buy. But what should you do now? Should you buy some to bulk up your portfolio, whilst being careful not to be “overweight” or indeed “underweight” in the shares.

Accumulate” and “add” are two other recommendations that need further qualification. Do they mean you need to buy some more if you already have a few shares, but don’t buy any if you don’t already own any? In which case, should you “avoid”, which is another common broker recommendation.

Underperform” and “outperform” are two more curious recommendations. In the case of something that underperforms, does it suggest the shares will underperform the sector or the entire market? But if a share is expected to underperform, then shouldn’t a sell recommendation be more appropriate?

Truth is, brokers are often reluctant to issue sell recommendations for fear of upsetting corporate clients by issuing unfavourable reports. Consequently, there may be more buy recommendations than advice to sell shares. That may also help explain why recommendations not to buy shares are dressed up in fancy understatements that to all intents and purposes mean a sell.

Another thing to bear in mind is that a lot of the recommendations that we read in newspapers and magazines are already quite old. So by the time we hear about them, the tips have already have grown beards.

As I see it, broker recommendations are meaningless without the accompanying notes that detail an analyst’s research. Their investigations can sometimes be quite thorough, and may even help us draw our own conclusions as to whether to buy, sell or hold a share.

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