Upgraded Broker Ratings

I'm sure a lot of you have experienced the pleasure of waking up and seeing that a covering broker upgraded their rating on one of your stocks.

I'm also guessing that you probably experienced the opposite, and saw one of the brokers downgrade your stock as well.

While nobody can perfectly guard against downgrades (or forecast all upgrades), it's important to know how the market reacts so you can stay in your upgraded winners (or buy if you’re on the fence). It's also important so you can consider getting out if a downgrade comes your way.

When I'm screening for new stocks, I like to look for companies that have recently seen a broker rating upgrade. Tests have proven that stocks with broker rating upgrades outperform those that don't get upgraded, and outperform even more dramatically those stocks that get downgraded.

By how much?

I created three screens and ran some tests. Each screen used a price and volume qualifier of >= $5 and >= 50,000 shares traded daily (avg. 20 day volume). I then added the Average Broker Rating Change over the last 4 weeks filter.

Screen 1: had no upgrades or downgrades –- the ABR remained the same, i.e., no change.

Screen 2: looked for only those companies that received upgrades (positive changes in their average broker rating).

Screen 3: screened for only those stocks that have been downgraded, i.e., negative change in their average broker rating.

The tests confirmed what I had already suspected, though the magnitude was a lot larger. With the Research Wizard's Advanced Backtester, I ran 3 separate tests on each of the 3 different test screens using a 1-week rebalancing period over the last (nearly) 10 years (2000 thru Oct. 2009) to see just how different the results would be with these different filters.

Results

The screen with no upgrades or downgrades (their rating, whatever it was, stayed the same) produced an average compounded annual growth rate of 4.7%.

The screen with only positive broker rating upgrades produced a compounded annual growth rate of 9.3%.

The screen with only downgrades, however, performed significantly worse, with an average annual return of -1.3%.

For the sake of illustration: using a hypothetical $100,000 investment, the screen with the positive broker rating changes would have gained an average of $9,300 a year, while the screen with the downgrades would have lost over -$1,300. That's more than a $10,000 annual difference in fortune, and literally the difference between a gain and a loss.

After running the upgrades screen, I added the Zacks #1 Rank (“strong buy”) and it increased the returns by more than 2½ times, taking it from a 9.3% average annual return to an 23.6% average annual return.

Here are 5 stocks from that list for this week (12/1/09):

CAT Caterpillar Inc.
EMN Eastman Chemical Company
MBT Mobile TeleSystems OJSC
SAM The Boston Beer Company, Inc.
SEE Sealed Air Corporation

All of these companies have a Zacks #1 Rank and have seen their average broker ratings upgraded within the last 4 weeks.

Get the rest of the stocks on this list and sign up for your free trial of the Research Wizard. Start using this idea in your own screens and start putting your own ideas to the test. It’s easy to do and you’ll be on your way to picking better stocks immediately.

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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

Disclosure: Performance information for Zacks’ portfolios and strategies are available at: http://www.zacks.com/performance.

Read the full analyst report on EMN

Read the full analyst report on SAM

Read the full analyst report on CAT

Read the full analyst report on MBT

Read the full analyst report on SEE