Question

In the world of stock selections, it is common to find statements such as “Automatic Data Processing gets an upgrade from a ‘hold to a buy’ at J.P. Morgan Chase, with a target price of $190,” and “Apple is downgraded from a ‘buy” to a hold’ at Goldman Sachs, with a target price of $280.” In terms of the rapidity and breadth with which financial markets incorporate new information, should any of us believe these recommendations are valuable; that is, will investments in these stocks lead to superior gains? Please be precise and thorough. (Note: Your answer cannot be a simple opinion. There is a definite and factual answer.)

Answer 1

Yes, we should believe that these recommendations are valuable despite the fact that financial markets now incorporate new information with high degree of rapidity and growth.

This is because of the fact that these brokerage and investment banking companies like J.P. Morgan Chase and Goldman Sachs do a comprehensive research on a company and then determine the growth prospects of its stock based on its underlying fundamentals. These companies like J.P. Morgan Chase and Goldman Sachs do both in-depth qualitative and quantitative analysis of a company and its stock to determine the intrinsic value. Quantitative analysis is done through methods like discounted cash flow analysis and relative valuation analysis. Besides this they also incorporate technical analysis which makes use of various statistical and mathematical tools.

The market, on an overall basis, fails to determine the intrinsic value of a stock in such a comprehensive manner as these entities like J.P. Morgan Chase and Goldman Sachs. These entities have an in-depth and unique understanding of the business models of the companies that they cover and hence their recommendations are valuable. It should, however, be noted that these recommendations should not be followed blindly and there can be situations in which the recommendations can go wrong if market conditions, state of the economy and business model of the company changes significantly.