Why it's Best to Ignore Analysts' 'Best Picks'
First Solar had a huge day, rising 12 percent to a 52-week high. But if you were listening to JPMorgan, the move was probably a total shock. In its "Year Ahead 2013" guide, JPMorgan made a point of advising against only one stock: First Solar.
In addition to that one "avoid" idea, JPMorgan listed its 72 best long ideas. But embarrassingly, with its 44 percent rise this year, including Wednesday's run-up, First Solar is outperforming 71 of JPMorgan's 72 "best" ideas. (The one "best" stock that has outperformed First Solar is semiconductor maker Cree.) Of course, First Solar has long been considered a "broken story," and started the year as a widely hated stock across the Street.
In JPMorgan's defense, its 72 best ideas are, in fact, beating the S&P 500 this year—but by less than a percent.
JPMorgan did a bit better in 2012, when its average long stock idea ran up by 15.5 percent, beating the S&P 500's 10.8 percent performance by a healthy margin. Unfortunately, the four stocks awkwardly labeled "best avoid stock picks" rallied 11.1 percent, also beating the S&P. In fact, the only 2012 "avoid" stock that actually dropped that year was First Solar.
JPMorgan is not alone in making bad calls. As Princeton professor Burton Malkiel wrote in his classic book "A Random Walk Down Wall Street": "Security analysts have tremendous difficulty in providing their basic function of forecasting company earnings prospects. Investors who put blind faith in such forecasts in making their investment selections are in for some rude disappointments."
The view of RiverTwice Research President Zachary Karabell is a bit less extreme.
Analysts at companies like JPMorgan "really know the industries, and they know what's going on with these companies. That's what they're good at," Karabell told CNBC.com. "But they're not good at picking stocks."
For that reason, listening to "best picks" lists "is among the worst of the ways to construct a portfolio," Karabell said. "They may be marginally better than a dartboard, but maybe not."
Stutland Volatility Group Managing Member Brian Stutland emphasized the importance of doing one's own research.
"I obviously value what analysts are saying," Stutland said. "But at some point you've got to digest that and form your own opinion. Especially as an individual investor, you always have to do your own homework."