Two weeks ago, I expressed caution over Spotify Technology (SPOT) in the wake of sellers fading an extremely bullish upgrade from an analyst at KeyBanc. That upgrade to overweight from sector weight included a $340 price target. The contrary and surprising trading action right after the analyst call was telling. A week after KeyBanc, an analyst at Goldman Sachs (GS) started SPOT at a neutral rating. SPOT traded down to support at its 50-day moving average (DMA) that day and bounced. The following week, DZ Bank increased the pressure with an outright sell and a $200 price target. The dour assessments held sway over the trading action and completely cancelled out the bullishness of the KeyBanc analyst. The three weeks of trading action demonstrated the hazard in analyst calls.
Over-reacting is a primary hazard in analyst calls. A single analyst call does not represent the final word by analysts In the case of SPOT. The immediate selling essentially warned of bad news to come. Subsequent analysts completely contradicted the lofty $340 price target for SPOT. Similarly, owning individual stocks comes with the hazard in analyst calls. An investor’s portfolio could be minding its business when a negative analyst assessment suddenly interrupts the investing thesis. So who gets the final word In this soup of conflicting reports and opinions?
The Analyst Consensus
One way to negotiate around individual analyst calls is to monitor the aggregate or “consensus” view. According to Seeking Alpha, 28 analysts have generated a near balanced mix of opinions: 11 very bullish ratings, 3 bullish, 10 neutral, 1 bearish, and 3 very bearish ratings. While Seeking Alpha reports this as a bullish rating with a 3.6 average, I count neutral ratings as borderline bearish and thus see an even split in opinion. Under these conditions, any given day is just as likely to generate a bullish opinion as a bearish opinion. In other words, the hazard in analyst calls for SPOT comes from the potential for a whiplash in opinion similar to September’s events.
The Trade Despite the Hazard In Analyst Calls
Ultimately, my bullish thesis on SPOT goes back to the massive $1.0B stock repurchase program the company announced on August 20th. SPOT gained 5.6% that day and continued to rally from there. The current sell-off has pushed SPOT just 4 points above the close of that day. Accordingly, I am warming up to buy back into SPOT on the assumption the bottom will hold from company repurchasing activity and investors following suit. Also note that DZ Bank pegged its bearish price target right at the August lows.
The hazard in analyst calls can become the good news as price moves to lower extremes. For Spotify Technology, the bullish analysts can become more likely to reiterate ratings based on the stock buyback (sprinkled with some additional bullish narrative). New analyst calls could call the pullback a buying opportunity. Either way, the downside risk in SPOT should decrease significantly the closer the stock gets to the August lows.
Of course, the current dangers in the stock market loom large over any bullish theses. Accordingly, absent a convincing return of buyers in SPOT, I am still in no rush to jump back into a position (likely another call option spread).
Be careful out there!
Full disclosure: no positions
Interesting point about neutral analysts’ opinions being effectively bearish. Obviously, explicitly neutral opinions reduce liquidity: investors who are guided by analyst opinions will neither buy nor sell a stock on which their favorite analysts are noncommittal. On the other hand, lack of liquidity exacerbates moves in either direction.
Taken to a logical extreme, it would seem that long-only investors should look for stocks on which every analyst is bearish. It has nowhere to go but up, right?
That kind of extreme contrary thinking only works if there is at least a shred of hope that a bullish thesis makes sense. For example, if analysts are all bearish because a company’s financial controls have collapsed….avoid!
I also consider neutral to essentially be bearish because analysts are generally not inclined to bad mouth companies. They want to maintain access to management and have polite conversations in earnings conference calls. Moreover, they want to leave the door open for securities business. In other words, it takes a LOT for an analyst to make a bearish ratings call. Analysts also hate being caught leaning the wrong way against market momentum. It’s easier to keep issuing bullish opinions in the expectation that in the “long-term” eventually price will come around. Much harder to stay bearish when a stock keeps running higher since price may “never” come back down to the lower level.