Stock Recommendations

Everyone is looking for an edge in the stock market, and quite often, traders turn to stock analysts for their stock recommendations to give them that edge.

Stock analysts sift through company reports and filings, talk to management, probe clients and competitors to basically do whatever they can to find out if a company is healthy and growing or sick and dwindling. Because this is incredibly challenging work, stock analysts typically only monitor one or two companies at a time.

In many situations, the economic environment is sufficiently complex that decision

makers are uncertain about the impact of their decisions. In today's uncertain market,

investors may be doubtful about the consequences of investing in a particular stock

on their retirement savings. In these situations, investors often turn to experts

for advice, guidance and stock recommendations. A key difficulty facing investors is that the motives of the expert providing advice may not be transparent. This situation commonly

arises in the interaction between investors and financial research analysts.

A key concern of regulators in proposing rules and procedures designed to preserve the

freedom of analysts is that even a potential conflict of interest may undermine

the information content of their stock reports and recommendations. While it is possible for stock prices to be semi-responsive to recommendations, a fully responsive stock price can never occur in equilibrium if there is any positive probability that a stock analyst's motivation is misaligned.

Overall, optimistic stock recommendations have become less frequent and more informative, whereas neutral and pessimistic stock recommendations have become more frequent and less informative. More importantly, the overall informativeness of stock recommendations has declined. The likelihood of issuing optimistic stock recommendations no longer depends on whether analysts are affiliated with the covered firm, although affiliated analysts are still reluctant to issue pessimistic recommendations.

Typically, stock analysts issue "Buy" and "Sell" recommendations on the stocks they watch. Many investors believe these stock recommendations are less useful for two reasons: they are too general and they may be unduly influenced by external forces.

A few stock analysts work for firms that do more than just analyze stocks. Sometimes, the other objectives of the firm are, or appear to be, in conflict with the objectives of the analyst to give an unbiased stock recommendation. This causes some investors to have less confidence in the recommendations from some analysts.