Source: Barron's

If you want to select stocks through data analysis, you can review a company's performance, or predict the expected growth rate of revenue, profit, and cash flow, and you can also evaluate the valuation of stock prices compared to expected future income, profit, or cash flow.

Of course, you can also refer to stock analysts' ratings.

Analysts working for securities brokerage firms will rate stocks for buying, selling, or holding, and give target share prices. Analysts also estimate the company's revenue and profit. Every quarter, when companies release performance reports, financial media will report whether these companies' performance exceeds or falls short of expectations. As time progresses, rolling profit expectations rise over the next 12 months, which is a good thing, as rising profit expectations can support the rise in stock prices.

But how good are analysts at selecting stocks over the long term? This is not an easy question to answer, but let's first simply compare the performance between a group of stocks highly rated by analysts and a group of stocks selected through analysis of performance data.

Here's what analysts were at five years ago$S&P 500 Index (.SPX.US)$It is the most popular stock selection, and shows how these stocks have performed since they were selected. To make a comparison, we'll also look at the companies with the highest average return five years ago to see how they performed.

First, let's take a look at how analysts who work for securities brokerage firms, also known as sell-side analysts, do stock ratings.

Seller Rating

Notably, it is common practice for sell-side analysts to set target prices for stocks over the next 12 months, but this is a short time period for serious long-term investors. For example,$Microsoft (MSFT.US)$The stock had a return of 283% over the past five years as of last Friday, including dividend reinvestment. But the stock fell 28% in 2022, then rebounded 58% in 2023, and Microsoft's return was “only” 14% from the end of 2021. Meanwhile, the S&P 500 has returned 3% since the end of 2021, while the index's five-year return is 85%. This all explains why long-term investors should consider the best time dimension to consider years rather than just focusing on the target price for the next 12 months.

Now let's take a look at sell-side analysts' ratings. A quick look at the S&P 500 shows that most sellers' ratings are positive. Seller analysts surveyed by FactSet gave 54% of the 500 listed companies a majority buy or equal rating, but none received most sales or the same rating, and only three received 50% half of the sales ratings:$T. Rowe Price (TROW.US)$ .$Robert Half (RHI.US)$und$Expeditors International (EXPD.US)$ .

On March 14, analysts surveyed by FactSet gave 74 listed companies in the S&P 500 index a buying rating of at least 75%. Combined with target stock prices, they came up with a list of the 20 stocks most favored by analysts.

A look back at Wall Street's most popular stocks five years ago

Starting with the current S&P 500, we can look back at analysts' ratings and target prices five years ago to see which companies Wall Street analysts favored at the time.

First, as of March 22, 2019, 484 listed companies in the current S&P 500 have received ratings from at least five analysts in the FactSet survey. Of these 484 companies, 80 were rated “buy” or equivalent by at least 75% of analysts. Of these, these 10 companies had the most room to increase in the consistent target price at the time:

The returns of the five companies exceeded the S&P 500 return of 85%, which is really good. One of these companies$Tapestry (TPR.US)$The overall return was 75%, and none of the companies experienced a decline.

Even professional investment managers will be happy that half of the stocks in the portfolio outperform the market.

How did ROIC return on capital stock selection perform

Last month, we conducted a long-term review and found that there is a strong correlation between outperforming the S&P 500 and investing in companies with high return on capital.

A company's return on capital (ROIC) is the sum of its net profit divided by the book value of common stock, preferred stock, long-term debt, and capitalized lease debt.

This is an annualized data which highlights the efficiency of the company's management in allocating capital. Some industries will naturally have a higher ROIC return on capital than others because they are less capital intensive. Other companies are trying to avoid raising additional capital to maintain business operations, such as Apple, etc., while also reducing the number of their shares (and their capital) by repurchasing shares. Their return on capital ROIC has continued to rise over the years.

FactSet calculates the ROIC for each earnings quarter of a listed company by reviewing data from the past four quarters, so ROIC is always an annualized data that has been rolled continuously for 12 months.

For the five-year ROIC up to March 22, 2019, we once again looked at FactSet's ROIC data up to that date, starting with the current S&P 500 constituent stocks, then reviewed the past four earnings quarters, eight quarters, and so on, and obtained five 12-month ROIC averages.

As of March 22, 2019, the 10 companies in the S&P 500 had the highest return on capital in five years. The table also includes seller ratings as of that date and stock price performance for the five years up to March 22, 2024:

In this list of stocks selected through ROIC return on capital, as of March 22, 6 companies outperformed the S&P 500 index.$HP Inc (HPQ.US)$This was followed by a return of 83%.

But the ROIC is the highest$VeriSign (VRSN.US)$ However, it was the second-worst performing company on the list, far less than any company on the first stock list favored by analysts five years ago.$Boeing (BA.US)$The stock price of fell 47% in the five years ending March 22, while the worst performing company on the analysts' list$Humana (HUM.US)$The return over five years was 32%.

Other observations on the list:

1. The 10 stocks most favored by analysts and the 10 stocks with the best ROIC performance are mutually exclusive.

2. Analysts favored five companies on the list with three-digit five-year returns, and six companies on the ROIC list have three-digit five-year returns.

In summary, if judged from the number of stocks that performed better, the ROIC analysis method is more effective, but the list of stocks most favored by analysts is safer.

Both methods are useful, and investors should consider all useful sources of information when making investment decisions, including financial results as well as analyst ratings and target prices.

edit/lambor