FYI | Jul 20 2006
By Greg Peel
JP Morgan’s senior bank analyst, Brian Johnson, is one of the most respected analysts in the market. His scrutiny is backed by many years of experience and his analysis is thoughtful and lacking in any tendency to be swept along with consensus sentiment. He has also been riding a bicycle to work since oil was US$20/bbl and he is a strong supporter of beverage stocks.
Johnson’s report on St George Bank (SGB) today provides a good opportunity to possibly defray a few misconceptions about analysts’ stock recommendations or ratings.
Analysts variously use the ratings "Buy", "Outperform" and "Overweight" when they are positive about a stock, "Hold" or "Neutral" when they are indifferent and "Sell", "Underperform" or "Underweight" when they are negative.
In order to gauge a consensus view on a stock, FN Arena lumps ratings into the three distinct categories of "Buy/Hold/Sell". This is simply intended as a guide to analyst sentiment. The risk for the inexperienced investor is to assume "Buy" means specifically that there is a profit to be made.
This may well prove to be the case, but all broker ratings work off a basis of "relative" as opposed to "absolute" value. Absolute value is that which suggests you will specifically make or lose money on a stock. Relative value is that which suggests you will derive a better or worse result from this stock than you will with others in the index.
This may well mean you will lose less money, rather then simply you will make money.
Analysts tend to set ratings on a relative basis of current trading price versus their own stock valuation. If the current price is lower than the target, it’s a Buy. If the price is near the target, it’s a Hold, and if it’s above the target, it’s a Sell.
Some brokers work their ratings off mathematical algorithms. In other words, ratings changes are automatically triggered by stock price movements relative to target prices. Other brokers, JP Morgan included, prefer to qualify their ratings with an anecdotal input alongside pure price differentials.
St George Bank is a case in point.
Johnson has set an Overweight rating for St George. However, his target price is $27.86 and yesterday’s close was $28.20. This might appear incongruous.
Says Johnson: "Against the backdrop of an expensive sector SGB offers relative, but not absolute dollar value, and in the context of a sector neutral ratings framework we continue to rate SGB an OVERWEIGHT. The key risk to this share price target is the anticipated upward pressure on bond yields and the prospect of increasing competition."
What Johnson is saying is that he has given the banking sector as a whole a Neutral rating because he feels most banking stocks are currently well or overpriced. This is despite the sector’s value as a defensive play. However, within the sector St George Bank is undervalued, not overvalued like its weightier peers.
Johnson feels the St George share price has drifted down on consensus that is below guidance and below his own appraisal. Thus he recommends that within a portfolio St George Bank should be afforded a higher weighting than its peers, and than other stocks in the general index. Thus the Overweight call.
It is important that investors look through analyst ratings and do not take them on face value alone. Read the supporting opinion that accompanies an analyst report. It may well be that one "Buy" is a very different story to another "Buy". There could be absolute returns to be made, or perhaps only relative returns to be made.
Even a negative return, if less negative than peers, may justify the wisdom of a Buy, Overweight or Outperform rating.
If in doubt, please contact a stock broker and even ask to speak directly to the analyst. A good analyst will happily afford you the time.