Shades of bullishness

May 29, 2009 in Finance

FT Alphaville has a post up regarding new research from Citi on how analysts make recommendations. It is accompnaied by this graph:

The graph shows the average recommendation across all analyst-covered stocks, for the last 15 years. A stock gets a 1 if every analyst recommends buying it; a 5 is given to a universal sell; 3 is neutral. The graph shows the average rating over time. Alphaville notes:

Basically it shows that over the last 15 years analysts have been moderately positive on stocks with an average score of circa 2.47. They were the most bullish at the end of 1999, then spent the next three years becoming increasingly bearish. Bullishness was on the rise between 2002 and mid-2007, before the analysts became bearish again.

I think the graph is somewhat misleading.  Firstly, the range of values here - roughly 2.25 to 2.65 - only encompass 10% of the total possible range from 1 to 5. Thus, it's a stretch to consider any of these values much more "bullish" or "bearish" than any other as they are concentrated in a very tight cluster. Without some knowledge of the distribution of ratings, it's hard to draw a conclusion.  If all stocks were 2's, 3's, and 4's, then the graph has more validity than, say, if stocks only had 1's or 5's. An extreme example to be sure, but the variance of the ratings distribution is critical to interpreting any change in the mean rating.

Second, Alphaville notes that the average of 2.47 is slightly bullish. What's more, the minimum and maximum ratings are both bullish as well. I think the graph is misleadingly labeled when it says "bullish" and "bearish" along the right axis. Those labels, taken together with the horizontal average line, appear to indicate that ratings above the line are bearish. In fact, none of the average ratings are bearish - ones above the line are merely more bearish than ones below, though still bullish themselves. "More bullish" and "more bearish" would have been more appropriate labels; "More bullish" and "less bullish" would have been even better.

At the end of the day, is anyone surprised by these findings?

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