Investors often rely on analyst recommendations when deciding whether to buy, sell or hold a stock. Media reports of rating changes by these brokerage firm-based (or sell-side) analysts often influence a stock’s price, but do they really matter?

Let’s take a look at what these Wall Street heavyweights have to say about Dollar Tree (DLTR) before we discuss the reliability of broker recommendations and how to use them to your advantage.

Dollar Tree currently has an average broker recommendation (ABR) of 1.95 on a scale of 1 to 5 (Strong Buy to Strong Sell), calculated based on the actual recommendations (Buy, Hold, Sell, etc.) of 22 brokerage firms. An ABR of 1.95 is roughly between Strong Buy and Buy.

Of the 22 recommendations from which the current ABR is derived, 12 are “Strong Buy”, which corresponds to 54.6% of all recommendations.

Brokerage Recommendation Trends for DLTR

Check Dollar Tree price target and stock forecast here>>>

Although the ABR encourages buying Dollar Tree, it may not be wise to make an investment decision based solely on this information. Several studies have shown that broker recommendations do little to no good in helping investors select stocks with the best upside potential.

Wondering why? Because of brokerage firms’ vested interest in a stock they cover, their analysts tend to rate it with a strong positive bias. According to our research, brokerage firms issue five “Strong Buy” recommendations for every “Strong Sell” recommendation.

In other words, their interests do not always align with those of retail investors and rarely provide any indication of where a stock’s price might actually go. Therefore, this information might be best used to validate your own research or an indicator that has proven extremely successful in predicting a stock’s price movement.

With an impressive, outside-audited track record, our proprietary stock evaluation tool, the Zacks Rank, which categorizes stocks into five groups ranging from Zacks Rank #1 (Strong Buy) to Zacks Rank #5 (Strong Sell), is a reliable indicator of a stock’s near-term price performance. Validating the Zacks Rank with ABR can therefore go a long way in making a profitable investment decision.

ABR should not be confused with the Zacks Rank

Although Zacks Rank and ABR both appear on a scale of 1 to 5, they are two completely different metrics.

The ABR is calculated based solely on broker recommendations and is typically displayed with decimals (example: 1.28). In contrast, the Zacks Rank is a quantitative model that allows investors to harness the power of earnings estimate revisions. It is displayed in whole numbers – 1 through 5.

The story continues

It has always been, and still is, the case that brokerage firm analysts are overly optimistic in their recommendations. Due to the self-interest of their employers, these analysts give more favorable ratings than their research would justify, and in doing so, mislead investors far more often than they help them.

On the other hand, earnings estimate revisions form the core of the Zacks Rank, and empirical research shows a strong correlation between trends in earnings estimate revisions and near-term stock price movements.

In addition, the different levels of the Zacks Rank are proportionally applied to all stocks for which brokerage analysts provide earnings estimates for the current year. In other words, this tool always maintains a balance among the five ranks it assigns.

There is also a key difference between the ABR and the Zacks Rank when it comes to timeliness. When you look at the ABR, it may not be up to date. However, since broker analysts are constantly revising their earnings estimates to reflect changing business trends and their actions are reflected in the Zacks Rank quickly enough, it is always up to date in predicting future stock prices.

Is DLTR a good investment?

In terms of earnings estimate revisions for Dollar Tree, the Zacks Consensus Estimate for the current year has declined 0.7% to $6.58 over the past month.

The increasing pessimism among analysts regarding the company’s earnings prospects, which is reflected in the strong consensus among analysts in reducing their earnings per share estimates, could be a legitimate reason for a short-term drop in the share price.

The magnitude of the recent consensus estimate change, along with three other factors related to earnings estimates, have resulted in a Zacks Rank #4 (Sell) for Dollar Tree. The complete list of today’s Zacks Rank #1 (Strong Buy) stocks can be found here >>>>

Therefore, it may be wise to approach the Purchase Equivalent ABR for Dollar Tree with a grain of salt.

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