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Investors often turn to recommendations made by Wall Street analysts before making a Buy, Sell, or Hold decision about a stock. While media reports about rating changes by these brokerage-firm employed (or sell-side) analysts often affect a stock's price, do they really matter?
Let's take a look at what these Wall Street heavyweights have to say about SM Energy (SM) before we discuss the reliability of brokerage recommendations and how to use them to your advantage.
SM Energy currently has an average brokerage recommendation (ABR) of 1.79, on a scale of 1 to 5 (Strong Buy to Strong Sell), calculated based on the actual recommendations (Buy, Hold, Sell, etc.) made by 14 brokerage firms. An ABR of 1.79 approximates between Strong Buy and Buy.
Of the 14 recommendations that derive the current ABR, eight are Strong Buy and one is Buy. Strong Buy and Buy respectively account for 57.1% and 7.1% of all recommendations.
Brokerage Recommendation Trends for SM
While the ABR calls for buying SM Energy, it may not be wise to make an investment decision solely based on this information. Several studies have shown limited to no success of brokerage recommendations in guiding investors to pick stocks with the best price increase potential.
Do you wonder why? As a result of the vested interest of brokerage firms in a stock they cover, their analysts tend to rate it with a strong positive bias. According to our research, brokerage firms assign five "Strong Buy" recommendations for every "Strong Sell" recommendation.
In other words, their interests aren't always aligned with retail investors, rarely indicating where the price of a stock could actually be heading. Therefore, the best use of this information could be validating your own research or an indicator that has proven to be highly successful in predicting a stock's price movement.
Zacks Rank, our proprietary stock rating tool with an impressive externally audited track record, categorizes stocks into five groups, ranging from Zacks Rank #1 (Strong Buy) to Zacks Rank #5 (Strong Sell), and is an effective indicator of a stock's price performance in the near future. Therefore, using the ABR to validate the Zacks Rank could be an efficient way of making a profitable investment decision.
Zacks Rank Should Not Be Confused With ABR
In spite of the fact that Zacks Rank and ABR both appear on a scale from 1 to 5, they are two completely different measures.
The ABR is calculated solely based on brokerage recommendations and is typically displayed with decimals (example: 1.28). In contrast, the Zacks Rank is a quantitative model allowing investors to harness the power of earnings estimate revisions. It is displayed in whole numbers -- 1 to 5.
Analysts employed by brokerage firms have been and continue to be overly optimistic with their recommendations. Since the ratings issued by these analysts are more favorable than their research would support because of the vested interest of their employers, they mislead investors far more often than they guide.
On the other hand, earnings estimate revisions are at the core of the Zacks Rank. And empirical research shows a strong correlation between trends in earnings estimate revisions and near-term stock price movements.
In addition, the different Zacks Rank grades are applied proportionately to all stocks for which brokerage analysts provide current-year earnings estimates. In other words, this tool always maintains a balance among its five ranks.
Another key difference between the ABR and Zacks Rank is freshness. The ABR is not necessarily up-to-date when you look at it. But, since brokerage analysts keep revising their earnings estimates to account for a company's changing business trends, and their actions get reflected in the Zacks Rank quickly enough, it is always timely in indicating future price movements.
Is SM a Good Investment?
In terms of earnings estimate revisions for SM Energy, the Zacks Consensus Estimate for the current year has remained unchanged over the past month at $7.57.
Analysts' steady views regarding the company's earnings prospects, as indicated by an unchanged consensus estimate, could be a legitimate reason for the stock to perform in line with the broader market in the near term.
The size of the recent change in the consensus estimate, along with three other factors related to earnings estimates, has resulted in a Zacks Rank #3 (Hold) for SM Energy. You can see the complete list of today's Zacks Rank #1 (Strong Buy) stocks here
It may therefore be prudent to be a little cautious with the Buy-equivalent ABR for SM Energy.
Zacks Investment Research
SM Energy (SM) ended the recent trading session at $39.16, demonstrating a +0.98% swing from the preceding day's closing price. This change outpaced the S&P 500's 0.54% gain on the day. Elsewhere, the Dow gained 0.72%, while the tech-heavy Nasdaq added 0.65%.
The independent oil and gas company's shares have seen a decrease of 17% over the last month, not keeping up with the Oils-Energy sector's loss of 3.91% and the S&P 500's gain of 4.86%.
Market participants will be closely following the financial results of SM Energy in its upcoming release. The company's earnings per share (EPS) are projected to be $1.78, reflecting a 2.89% increase from the same quarter last year. Alongside, our most recent consensus estimate is anticipating revenue of $697.38 million, indicating an 8.81% upward movement from the same quarter last year.
In terms of the entire fiscal year, the Zacks Consensus Estimates predict earnings of $7.57 per share and a revenue of $2.84 billion, indicating changes of +28.52% and +19.52%, respectively, from the former year.
Any recent changes to analyst estimates for SM Energy should also be noted by investors. These recent revisions tend to reflect the evolving nature of short-term business trends. As a result, we can interpret positive estimate revisions as a good sign for the company's business outlook.
Based on our research, we believe these estimate revisions are directly related to near-team stock moves. To capitalize on this, we've crafted the Zacks Rank, a unique model that incorporates these estimate changes and offers a practical rating system.
The Zacks Rank system, which varies between #1 (Strong Buy) and #5 (Strong Sell), carries an impressive track record of exceeding expectations, confirmed by external audits, with stocks at #1 delivering an average annual return of +25% since 1988. Within the past 30 days, our consensus EPS projection has moved 0.42% higher. SM Energy is currently a Zacks Rank #3 (Hold).
From a valuation perspective, SM Energy is currently exchanging hands at a Forward P/E ratio of 5.13. This denotes a discount relative to the industry's average Forward P/E of 9.31.
The Oil and Gas - Exploration and Production - United States industry is part of the Oils-Energy sector. At present, this industry carries a Zacks Industry Rank of 213, placing it within the bottom 16% of over 250 industries.
The Zacks Industry Rank assesses the vigor of our specific industry groups by computing the average Zacks Rank of the individual stocks incorporated in the groups. Our research shows that the top 50% rated industries outperform the bottom half by a factor of 2 to 1.
Zacks Investment Research
SM Energy (SM) is one of the stocks most watched by Zacks.com visitors lately. So, it might be a good idea to review some of the factors that might affect the near-term performance of the stock.
Over the past month, shares of this independent oil and gas company have returned -13.5%, compared to the Zacks S&P 500 composite's +2.9% change. During this period, the Zacks Oil and Gas - Exploration and Production - United States industry, which SM Energy falls in, has lost 7%. The key question now is: What could be the stock's future direction?
Although media reports or rumors about a significant change in a company's business prospects usually cause its stock to trend and lead to an immediate price change, there are always certain fundamental factors that ultimately drive the buy-and-hold decision.
Earnings Estimate Revisions
Here at Zacks, we prioritize appraising the change in the projection of a company's future earnings over anything else. That's because we believe the present value of its future stream of earnings is what determines the fair value for its stock.
We essentially look at how sell-side analysts covering the stock are revising their earnings estimates to reflect the impact of the latest business trends. And if earnings estimates go up for a company, the fair value for its stock goes up. A higher fair value than the current market price drives investors' interest in buying the stock, leading to its price moving higher. This is why empirical research shows a strong correlation between trends in earnings estimate revisions and near-term stock price movements.
SM Energy is expected to post earnings of $1.78 per share for the current quarter, representing a year-over-year change of +2.9%. Over the last 30 days, the Zacks Consensus Estimate has changed -2.4%.
For the current fiscal year, the consensus earnings estimate of $7.57 points to a change of +28.5% from the prior year. Over the last 30 days, this estimate has changed +0.4%.
For the next fiscal year, the consensus earnings estimate of $9.50 indicates a change of +25.6% from what SM Energy is expected to report a year ago. Over the past month, the estimate has changed +0.2%.
Having a strong externally audited track record, our proprietary stock rating tool, the Zacks Rank, offers a more conclusive picture of a stock's price direction in the near term, since it effectively harnesses the power of earnings estimate revisions. Due to the size of the recent change in the consensus estimate, along with three other factors related to earnings estimates, SM Energy is rated Zacks Rank #3 (Hold).
The chart below shows the evolution of the company's forward 12-month consensus EPS estimate:
12 Month EPS
Projected Revenue Growth
While earnings growth is arguably the most superior indicator of a company's financial health, nothing happens as such if a business isn't able to grow its revenues. After all, it's nearly impossible for a company to increase its earnings for an extended period without increasing its revenues. So, it's important to know a company's potential revenue growth.
For SM Energy, the consensus sales estimate for the current quarter of $697.38 million indicates a year-over-year change of +8.8%. For the current and next fiscal years, $2.84 billion and $3.5 billion estimates indicate +19.5% and +23.3% changes, respectively.
Last Reported Results and Surprise History
SM Energy reported revenues of $634.56 million in the last reported quarter, representing a year-over-year change of +15.2%. EPS of $1.85 for the same period compares with $1.28 a year ago.
Compared to the Zacks Consensus Estimate of $629.58 million, the reported revenues represent a surprise of +0.79%. The EPS surprise was +17.83%.
The company beat consensus EPS estimates in each of the trailing four quarters. The company topped consensus revenue estimates two times over this period.
Valuation
No investment decision can be efficient without considering a stock's valuation. Whether a stock's current price rightly reflects the intrinsic value of the underlying business and the company's growth prospects is an essential determinant of its future price performance.
Comparing the current value of a company's valuation multiples, such as its price-to-earnings (P/E), price-to-sales (P/S), and price-to-cash flow (P/CF), to its own historical values helps ascertain whether its stock is fairly valued, overvalued, or undervalued, whereas comparing the company relative to its peers on these parameters gives a good sense of how reasonable its stock price is.
The Zacks Value Style Score (part of the Zacks Style Scores system), which pays close attention to both traditional and unconventional valuation metrics to grade stocks from A to F (an An is better than a B; a B is better than a C; and so on), is pretty helpful in identifying whether a stock is overvalued, rightly valued, or temporarily undervalued.
SM Energy is graded A on this front, indicating that it is trading at a discount to its peers. Click here to see the values of some of the valuation metrics that have driven this grade.
Conclusion
The facts discussed here and much other information on Zacks.com might help determine whether or not it's worthwhile paying attention to the market buzz about SM Energy. However, its Zacks Rank #3 does suggest that it may perform in line with the broader market in the near term.
Zacks Investment Research
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