How to judge whether it is time to follow – or go against – the crowd

With the FTSE 100 trading above 7,700 and the FTSE All-Share also setting new highs just under the 4,250 mark, investors are off to a good start in 2018 and momentum seems to be on their side.

The FTSE 100 and FTSE All-Share have both begun 2018 on an all-time high

Source: Thomson Reuters Datastream

However, the crushings handed out to Debenhams and Mothercare after their profit warnings and software firm Micro Focus after a mildly disappointing update contrast markedly with the strong gains seen at another retailer, Next, for example.

Over the last month, four mining stocks – Anglo American, BHP Billiton, Rio Tinto and Glencore – are all up by more than 15%. Yet sixteen FTSE 100 stocks have fallen over that time period and Micro Focus is bottom of the pile after a near-10% slide.

Granted, one month is not a fair time horizon over which to judge any investment. But such wide performance dispersion does show the dangers that can come with picking individual stocks.

Some may look to avoid such risk by getting a fund manager to pick stocks for them and investing in an actively-managed fund. Others may prefer to avoid the chance of human error altogether and buy an index tracker or exchange-traded fund and pay lower fees in the process, albeit in the knowledge their chosen tracker will not beat the index and it will follow it blindly lower should anything go wrong on a market-wide basis.

For those who would prefer to go it alone and pick their own stocks, the first challenge is how to sift through the 2,000 or so firms listed and quoted on the London Stock Exchange’s Main Market and AIM.

One possible way is to look at which stocks are most and least preferred in the research written by analysts and the leading investment banks and broking firms. Granted, this is primarily intended for institutional investors but websites such as www.brokerforecasts.com and www.digitallook.com provide a summary of how many analysts cover a stock and how many rate the stock a ‘buy’ or a ‘sell’ (or are sat on the fence with a ‘hold’).

For the fourth year in a row, AJ Bell has analysed the FTSE 350 to see which stocks are the most – and least – popular with the brokers, to see if this could provide any pointers for the year ahead.

We have also back-tested the data for 2017 to see whether the most widely liked stocks have done well and those that seem most disliked have done badly.

Results from 2017

One easy way to look at which stocks are popular and which are not (or which could be in fact too popular and overvalued and those which could be underloved and undervalued) is to assess which companies attract the highest percentage of ‘buy’ ratings from those analysts who research them (to see if they are worth buying) and those stocks which attract the highest percentage of ‘sell’ ratings (to see if they should be avoided).

In theory, the most popular names with the greatest percentage of ‘buys’ would do best and those with the fewest ‘buys’ (or greater number of ‘sells’) the worst.

Not so fast.

The results for the FTSE 100 do not make great reading for the analysts. (This is not to poke fun at them. In a former life this columnist worked as an equity analyst for an investment bank for 12 years covering technology stocks and therefore has first-hand experience of what a fiendishly tricky business this is).

This first table shows how the ten FTSE 100 firms that had the greatest percentage of ‘buy’ ratings in the first week of January 2017 fell by 9.3% between them, even as the index rose by 7.6%.

Worse still, the ten names with the lowest percentage of positive research ratings rose on average by 10.8% during the year, to beat both the index and the basket of most-liked names.

Most popular FTSE 100 stocks with brokers performed horribly in 2017

Source: Digital Look, Broker Forecasts, Thomson Reuters Datastream

More confusingly for private investors, the 10 stocks which were most aggressively given a ‘sell’ rating (and thus were the least popular) rose faster than both the FTSE 100 and the 10 names which did not attract a negative comment between them at the start of last year.

Least popular FTSE 100 stocks with brokers performed perfectly well in 2017, thank you very much

Source: Digital Look, Broker Forecasts, Thomson Reuters Datastream

Oh, dear.

Thankfully, the analysts found redemption in the FTSE 250, where coverage can be less intense and the scope for adding value through diligent analysis is greater. The results for the FTSE 350 (the 100 and the 250 combined) do suggest that broking research can add some value (a conclusion which would be hard to draw from the results on the FTSE 100, other than to say that doing the opposite to the experts was the best plan).

This next table shows how the ten FTSE 350 firms that had the greatest percentage of ‘buy’ ratings in the first week of January 2017 rose by a market-busting 35.4% between them, while the ten names with the lowest percentage of positive research ratings eked out only a meagre gain.

Most popular FTSE 350 stocks with brokers performed very strongly in 2017

Source: Digital Look, Broker Forecasts, Thomson Reuters Datastream

However, the most aggressively sold names again confounded the bears, rising faster on average than the FTSE 350 index and than the stocks which attracted no negative recommendations at all in January 2017.

Least popular FTSE 350 stocks with brokers also did well 2017

Source: Digital Look, Broker Forecasts, Thomson Reuters Datastream

Conclusions

The following conclusions can be drawn from this data:

• On the face of it, doing the opposite to the consensus/majority broker view served investors better overall in 2017 (just as it did in our prior surveys of 2015 and 2016’s broker ratings), showing the dangers of following the herd.
• That said, the most intensively favoured names in the FTSE 350 overall did do well, to suggest the trend can be investors’ friend and that analysts may find it easier to add value in the less-well-covered mid-cap sphere.
• The temptation to simply blindly do the opposite to the consensus should therefore be resisted, not least as the past is no guide to the future and because if making money in the markets was that simple then every one would already be doing it.
• The data above is based on one year (even if it did confirm the picture painted by 2015 and 2016, drawn by this equivalent column of a year ago). Yet the real power of equity investing (which comes particularly through the harvesting and reinvestment of dividends) is felt over periods of a decade, two decades or more (and note that this data looks only at capital and not total returns).

Ultimately, what the data does seem to show is the well-informed, diligent, expert broking community has little more idea of what is coming than anyone else, at least in the short term. And if they haven’t got a clue when it comes to trying to time the market, it does suggest that private investors should only try it if they are only too aware of the dangers and are willing to suffer and able to financially withstand losses in their quest for momentum-fuelled portfolio gains.

Ultimately, anyone prepared to pick their own stocks rather than pay a fund manager to do it for them must thoroughly research any company for themselves before they even think about buying its shares.

If this sounds difficult, well, it is but at least you can follow the lead of successful American investor Charlie Munger – Warren Buffett’s vice-chairman at Berkshire Hathaway – who boils it down to four things:

• One, do you understand the business?
• Two, does the business have intrinsic value or durable competitive value?
• Three, does management have integrity?
• Four, does the stock come at a reasonable valuation?

In other words, if you don’t understand the business, aren’t sure the company has pricing power, don’t trust the management or fear the shares are expensive, you may need to think again.

To boil that down even further, American investor, commentator and businessman Jim Rogers once asserted: “The more certain something is, the less likely it is to be profitable.” (Or, in other words, if the investment case is that blindingly obvious it is likely the market priced it in a long time ago).

Equally, if you like what you see, you shouldn’t be put off just because you are out of step with consensus – this means you may have unearthed a value nugget, assuming the stock passes the first three of Munger’s tests. Then you may be following Warren Buffett’s maxim that “You can’t buy what is popular and do well.”

Drum roll ...... names to watch in 2018

The FTSE 100 seemed to follow Warren Buffett's maxim in 2017 so it will be interesting to see how these names fare in 2018.

They are listed firstly by those with the index members which have the highest percentage of ‘buy’ ratings next to their name as the year begins. For any natural contrarians out there, it also shows the ten names which attract the lowest percentage of positive coverage.

The ten most popular FTSE 100 stocks with analysts on the basis of ‘buy’ ratings for 2018 (and the ten least)

Source: Digital Look, Broker Forecasts, Thomson Reuters Datastream

The next table features the list of least popular FTSE 100 stocks, those with the highest number of sell ratings. Again, the names which draw the fewest sell ratings are provided by way of a contrast.

The least popular FTSE 100 stocks with analysts on the basis of ‘sell’ ratings for 2018 (and those which attract no negative comment at all)

Source: Digital Look, Broker Forecasts, Thomson Reuters Datastream

The same tables then follow for the FTSE 350 in its entirety (excluding investment trusts).

The ten most popular FTSE 350 stocks with analysts on the basis of ‘buy’ ratings for 2018 (and the ten least)

Source: Digital Look, Broker Forecasts, Thomson Reuters Datastream

The least popular FTSE 350 stocks with analysts on the basis of ‘sell’ ratings for 2018 (and those which attract no negative comment at all)

Source: Digital Look, Broker Forecasts, Thomson Reuters Datastream

This column will keep a close eye on how all of these baskets of names fare in 2018 and will return to outline their performance at this time next year at the latest, to see whether momentum and running with the herd served investors well, or whether a more contrarian approach was required.

Russ Mould, AJ Bell Investment Director