Analyst estimates are an important component of Wall Street culture. Despite their importance, many individual investors ignore estimates, perhaps because they don’t understand the importance of Wall Street research. Research is expensive to produce and large firms don’t charge customers for their research. This fact points to the value of the research Wall Street produces.
Wall Street isn’t known for giving things away. Free research isn’t really free. Customers pay for research through commissions and fees and sometimes they direct business to firms because of the quality of the research.
Research departments consist of individuals with access to high-priced data systems who devote their time to verifying the data in the systems and plugging accurate numbers into models that provide price targets. Reports are distributed to the firm’s customers who are often institutional portfolio managers or traders working at large firms. In this way, research is like advertising for the firm that produces it and some customers will decide where they do business in order to access the work of the best analysts.
Analysts have a number of reasons to provide high quality research. If the customers value the product and find the price targets to be reasonably accurate, they will most likely place trades with the analyst’s firm. This generates commissions which can be surprisingly expensive for large investors. Mutual fund managers might pay $0.02 or $0.03 a share in commissions and large funds can trade millions of shares a day. This cost may seem high because, as individuals, many of us pay less than that. But large investors pay more because their orders might need special handling. It can be worth paying thousands of dollars in commissions when a skilled trading desk can avoid tipping other market participants to their orders.
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Commissions also buy access on Wall Street. To verify the data in a report, analysts often call and visit a company’s management. By developing personal relationships with management, analysts can often help arrange meetings for portfolio managers who want to talk with a company’s management team. This access has a value and the analysts are the gatekeepers for that process.
Analysts may also take pride in their work and want to develop accurate targets because accuracy is the measure of success in their work.
This means there are at least two reasons analysts strive to create high quality research — they can help their firms generate revenue and they take personal pride in their work. Firms bear the expense of research because it can generate higher revenue and profits for the firm.
As individuals, we can benefit from this work for free. Web sites like Yahoo and Google provide summaries of research. For many stocks we can find the consensus estimates of earnings and price targets for stocks. Consensus estimates are the average of all available estimates and are often more accurate than any individual estimate.
Understanding the value of research, I frequently screen stocks to find buy candidates. This week, I screened for low-priced stocks that analysts believe can gain at least 50% in the next year. These are stocks analysts have spent hours studying and determined they are deeply undervalued.
Companhia Siderurgica Nacional (NYSE: SID) is a vertically integrated steel company, involved in all aspects of the supply chain from the mining of iron ore to the production and sale of a range of steel products, including coated galvanized flat steel and tinplate. SID also operates a port terminal for containers, Sepetiba Tecon, at Itaguai Port, in the state of Rio de Janeiro. SID, a Brazilian company, is focused on the domestic steel market.
Brazil’s stock market has been pushed down by political turmoil in the country. The recent impeachment of the country’s president seems to be the set up for a potential bull market. The weekly chart below shows SID candlesticks with the Brazilian benchmark Bovespa index shown as the solid line. SID is highly correlated with the broad market. At the bottom of the chart, momentum, shown as the stochastics indicator, is bullish.
The two analysts who follow the stock have placed a target of $5.15 on SID, which is currently trading near $3 a share. This represents a potential gain of more than 70%.
RTI Surgical, Inc. (Nasdaq: RTIX) is a small medical supply company with sales of about $275 million in the past twelve months. The company makes orthopedic and other surgical implants that repair and promote the natural healing of human bone and other human tissues. In more technical terms, the company “processes donated human musculoskeletal and other tissue, including bone, cartilage, tendon, ligament, fascia lata, pericardium, sclera and dermal tissue, and bovine and porcine animal tissue in producing allograft and xenograft implants utilizing BIOCLEANSE, TUTOPLAST and CANCELLE SP sterilization processes, and manufactures metal and synthetic implants for distribution to hospitals and surgeons.”
Earnings have been volatile. Last year RTIX reported earnings per share (EPS) of $0.20. This year, EPS are expected to drop to $0.10 before rebounding to $0.17 next year and $0.23 in 2018. Three analysts follow the stock and have a mean price target of $5.33, a potential gain of more than 65%. As a small company with successful products, RTIX could be attractive to large companies as a possible acquisition.
XOMA Corporation (Nasdaq: XOMA) is a development-stage biotechnology company trading for less than $0.50 a share. The company focuses on the discovery and development of monoclonal antibody-based compounds in various stages of testing. It has five products that may be useful in the treatment of diabetes, thyroid disorders and inflammatory diseases.
The stock has been in a trading range and is currently near its 52-week lows. Four analysts follow the stock and have targets ranging from $0.85 to $2 with a mean of $1.32.
Highpower International, Inc., (Nasdaq: HPJ) is a China-based company that manufactures nickel metal hydride rechargeable batteries (Ni-MH) and lithium batteries for both consumer and industrial applications. Lithium-ion (Li-ion) and Lithium polymer rechargeable batteries are used for consumer applications, such as consumer electronic products, mobile devices and wireless communication products. HPJ also produces ordinary nickel cadmium (Ni-Cad) rechargeable batteries, as well as their non-rechargeable counterparts, and industrial batteries, which are designed for electric bikes, power tools and electric toys. It produces A, AA and AAA sized batteries in blister packing, as well as chargers and battery packs.
Sales topped $140 million in the past twelve months with EPS of $0.25 over that time. HPJ has been profitable in each of the past four years. The stock is trading at about 11 times earnings. Just one analyst follows the company and has a target of $12.86. This seems optimistic. With EPS growth averaging 26% a year in the past three years, a more conservative price target is $6.50. At this price, the stock would trade at a price-to-earnings (P/E) ratio of 26, an amount equal to its EPS growth rate.
Geron Corporation (Nasdaq: GERN) is a biopharmaceutical company that supports the clinical stage development of a telomerase inhibitor, Imetelstat, in hematologic myeloid malignancies by Janssen Biotech. Sales totaled $36 million in the past twelve months. Losses are expected in each of the next three years. As with all development-stage biotech companies, positive test results could lead to a large gain in the stock. Negative results could lead to a collapse in the stock price. Analysts appear to be optimistic. Four analysts follow the stock and have price targets ranging from $2.50 to $5, a potential gain of between less than 10% and more than 100%.
After a recent selloff, momentum has turned bullish and GERN could be in the early stages of an uptrend.
Analysts have devoted resources to these stocks and are bullish on their prospects. Because of their low prices, they carry relatively little risk and potentially large rewards. However, there is always the risk of a loss in any stock.
Action to take: Consider investing in these stocks but take action to manage the risks of any investment. Consider a stop 20% below the entry price of the stock and take profits when they are available.