Blending Schwab Stock Research With Other Sources

Key Points

  • Schwab has a number of research sources to help you select stocks.
  • We'll explore how to use Schwab Equity Ratings in conjunction with independent third-party stock research.
  • Helpful information for stock investors.

To help clients identify potential stocks to buy, hold, and sell, Schwab provides Schwab Equity Ratings and a number of independent third-party research sources, including Credit Suisse, Standard & Poor's, Ned Davis Research, Argus Research, Reuters, and Market Edge.

This wealth of resources can leave clients with a lot of information to digest. In fact, many clients have questions about how to use our research, such as:

  • How should Schwab Equity Ratings be used in conjunction with third-party research?
  • Should you buy, hold, or sell only when Schwab Equity Ratings and independent third-party opinions are in agreement?
  • What should you do when there's a conflict in guidance? For example, let's say that an independent third-party research source rates a stock as a "Buy" when its Schwab Equity Rating is D or F? Which guidance should you follow?

In this article, we'll take a look at how to use Schwab Equity Ratings and independent third-party research—and how not to use it—in your stock selection process.

How to use Schwab Equity Ratings and independent third-party research

Schwab recommends that clients start their investment process by considering A- and B-rated stocks for purchase, concentrating on the best-rated stocks (those with the lowest percentile ranks). And we recommend that you consider selling a stock if its rating drops to D or F (percentile ranks 71-100). We also recommend that clients do additional research using the tools available on our website, including third-party research.

We believe independent third-party research can supplement Schwab Equity Ratings in three ways.

First, third-party research may be useful in analyzing significant events that haven't been factored into a stock's Schwab Equity Rating. Ratings are produced each weekend, incorporating information available at the end of that week. So if a significant event occurs during the following week, the effect of that event—if any—won't be reflected in the Rating until the next Monday, when new Ratings are produced. In such situations, third-party research may be a more timely analysis of the potential impact of that event on the stock. Of course, you should check the date of a third-party research report to determine whether it reflects current events.

Second, in some cases a news story that impacts a stock may not be quantifiable. For example, this might include (but is definitely not limited to) product news (good or bad), company news such as management changes, spinoffs and acquisitions, or the entry or exit of competitors, and legal issues such as antitrust procedures, product liability litigation, an acknowledgement that previous financial statements must be restated, or environmental complaints. These types of events aren't always quantifiable, although over time brokerage firm analysts may weigh in with their views. Schwab Equity Ratings may not be able to immediately reflect the impact of those events in the rating, so you may want to consider third-party research for an additional perspective on the possible impact of such events.

Last, independent third-party research providers may be able to help you gain a broader understanding of industry- or economy-wide influences on a company's outlook. Year after year, Institutional Investor magazine's annual securities-analyst ratings emphasize that the most highly esteemed analysts are valued more for their knowledge of industry and economic trends and how they might affect a stock than for their ability to pick stocks or forecast earnings. Since Schwab Equity Ratings do not provide this type of guidance in a direct sense, you may want to take advantage of the industry and economic perspectives offered by third-party research.

How not to use independent third-party research

Simply stated, our approach regarding how not to use third-party research is: Don't override a stock's Schwab Equity Rating, particularly for D- and F-rated stocks, with the opinion of a third-party analyst. In fact, we would caution you against weighing the Rating and third-party opinions equally.

In our research, we've consistently found that buying those stocks most highly recommended by Wall Street analysts yet with Schwab Equity Ratings of D or F have produced poor results. We believe that clients should consider stocks with Schwab Equity Ratings of A or B, concentrating on the lowest (best) percentile ranks, and use additional third-party research information to help answer the question, "Is there something that might potentially invalidate this stock's Schwab Equity Rating?"

Limitations of independent third-party research

Keep in mind that there are a few limitations with third-party research. First, the universe of stocks covered by these sources can be significantly smaller than that of Schwab Equity Ratings. So if you're looking for an opinion on a specific stock, particularly one that's small or not well-known, there's a chance that you won't find any third-party opinions.

Second, you may notice that there don't seem to be many "sell" recommendations.1 There are lots of reasons for the scarcity of third-party sell recommendations—after all, if you were a stock researcher, it's unlikely you'd want to cover stocks with dismal outlooks. But as of November 7, 2013, for the 2,964 stocks that had both Schwab Equity Ratings and analyst recommendations, there were more than 30,400 individual analysts' recommendations—and less than 5.4% of those were "underperform" or "sell."

Since so few third-party recommendations are negative, it's worth a careful look when a stock you're thinking about buying—for example, one rated A or B—has a "sell" or "underperform" rating from one or more third-party sources. Check the research provider's report (enter the stock's ticker symbol, then select the "Reports" tab) to see, if possible, the rationale for the unfavorable rating. If the rationale seems valid to you, eliminate the stock and look for another—with approximately 150 A-rated and 750 B-rated stocks available, you should be able to find several worthwhile alternatives.

How do third-party "buy" recommendations fare?

With all those "buy" recommendations, how well does Wall Street research actually perform? Schwab has investigated this issue, and the answer may give you pause.

Take a look at the chart below. It shows that the most favorable recommendations (top 20%) of Wall Street analysts underperformed the returns of the 20% of stocks with the least favorable recommendations by 3% or more per year.

12-month returns of third-party analyst recommendations

 

12-month returns of analyst recommendations

Source: Schwab Center for Financial Research from December 31, 1993 to December 31, 2012. 

Research methodology

  • For this study, we established a universe of the top 2,000 market capitalization stocks at the beginning of each year (for example, from December 31, 1993). Then, within those 2,000 stocks, the stocks were ranked into uniform quintile portfolios (the top 20% of stocks were placed into portfolio 1, the next 20% into portfolio 2, and so on) based on consensus ratings.2
  • Stocks in each portfolio were held constant and average total returns (including dividends) over the subsequent one-year period (for example, through December 31, 1994) were compiled for each portfolio. No transaction costs were subtracted from returns. Returns shown in the chart are the average of each portfolio's annual returns over the 19-year period from December 31, 1993 to December 31, 2012.
  • Past performance is no guarantee of future performance.

In conclusion, when you're researching a stock, consider the following steps:

  • Consider purchasing A- and B-rated stocks (favor those that are A rated).
  • Consider selling a stock if the Rating drops to a D or lower.
  • Keep in mind that independent third-party research that may help you supplement your research. We don't believe that it should override a stock's Schwab Equity Rating.

Independent third-party research on Schwab.com by category

 

Research Source

Number of rated stocks

Ratings breakdown

Credit Suisse

846

• 375 "Outperform" • 367 "Neutral" • 104 "Underperform"

Ned Davis Research 

1,380

• 137 "Buy" • 1,105 "Hold" • 138 "Sell"

Standard & Poor's "STARS" ratings

1,139

• 68 "5 STARS" • 358 "4 STARS" • 601 "3 STARS" • 96 "2 STARS" • 16 "1 STAR"

Standard & Poor's "Earnings & Dividends" ratings

3,346

• 43 "A+" • 105 "A" • 159 "A-" • 469 "B+" • 628 "B" • 852 "B-" • 1,022 "C" • 88 "D"

Argus Research

443

• 210 "Buy" • 220 "Hold" • 13 "Sell"

Reuters Average Rating

4,534

• 692 "Buy" • 2,377 "Outperform" • 1,385 "Hold" • 73 "Underperform" • 7 "Sell"

Source: Schwab.com as of November 3, 2013.

 

Next Steps

To research which stocks may be right for you, log in to Stock Research.

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