Analysts Raise Ratings on Beat Up Spotify Stock

Spotify

We don’t generally find stock analysts changing their ratings on stocks to be all that interesting, but analysts becoming more bullish on Spotify right now does stand out.

The first thing that you need to understand about the work of stock analysts is that they don’t really speak to the goals of investors anywhere as much as people think, even though plenty of investors pay attention to such things.

It’s not that analysts don’t look at the big picture, but the primary task that they set themselves to do is to seek to predict movements over a shorter time frame than investors use. They still pore over fundamental data, things that are at least loosely correlated with the longer-term view that investors take, but apply it in the shorter-term, where it isn’t particularly meaningful, which is the main reason why this type of analysis isn’t very good.

Such things do matter in the long run because they do shape the preferences of the market to a degree certainly worth accounting for, and even though any sort of projection longer-term is a guess, we can make more educated guesses about these things if we look at what a company’s prospects may look like long-term.

If these analysts confined themselves to this, looking down the road and basing their projections on what they see, this could be of some value, even though we do need to realize that there is so much uncertainty out there that the best you can do with this is to draw out a longer-term roadmap and then ensure that, as you hold a stock, it hits its checkpoints at least reasonably.

This will involve things like looking at the history of the company, where its fundamentals are trending, where the competition is trending, as well as what kind of projections that we can come up with this by looking at all this as well as forecasting future demand and profitability. We need to know what the pie will look like down the road and what amount our company may expect.

This is not their task though, even though many people think that it is. They also believe that this information and these ratings are set up primarily to benefit investors, but the focus of this is instead on trading, not investing, and in particular, institutional trading.

These analysts actually work for institutions, and while they do share their analysis with the world, and there are various reasons why they do, providing guidance to investors isn’t really a priority and actually isn’t even on the list.

Institutions trade on various time frames, including being in trades for only microseconds, but their big positions are traded like a position trader would, and they are position traders for the most part. When you invest, you plan on keeping a stock for a good while, but position traders look to hold for anywhere from a few months to a year or two, where they ride trends that fit this scope.

This time frame is actually the sweet spot for institutions, as they trade in such large quantities that they cannot effectively turn over their portfolios that quickly, and therefore shorter time frames are not just practical. They do look to profit from trading so they aren’t looking to hold for many years either and do look to time their positions like traders would, so this is definitely a form of trading.

The Analysis that Stock Analysts Use Is Poorly Aligned with their Objectives

We might think that this longer trade horizon should bring fundamentals into the limelight, and plenty of fundamental analysts have that belief. While it isn’t that fundamental analysis is completely meaningless with position trading, if you are looking to trade trends, it is the trends that need to matter, which takes us into the realm of a different sort of analysis, the analysis of trends themselves.

We can observe, for instance, that a company is doing just fine business-wise, but the market may not like the stock so much. If fundamentals translated into stock prices in the way that many people assume, we’d actually see prices flat most of the time, with intermittent jolts whenever the fundamental outlook of a stock would change, which means that on most days price would not even move much if at all.

That is not how it all works though, and we instead see forces of supply and demand for the stock move considerably independent of these changes in fundamentals for a stock, which constitute all of a stock’s movement on most days as well as overall. Stocks do move when we see events such as earnings reports and other material changes involving a stock’s underlying business, and these things do need to be accounted for, but stock prices are mostly market driven.

Using analysis effectively on the scale of position trading therefore primarily involves technical analysis, but given that many of these analysts focus primarily on fundamentals, this takes them out of their element. Fundamental analysis is what they are trained to do, and regardless of how appropriate or effective it might be, it is still primarily used by default, even though technical analysis can play a minor role.

This causes a breakdown of their analysis, forcing them to attempt to take these long-term indicators and try to squeeze them into time frames that they are not well suited to. This is why we see them comparing business performance to price in the short term, comparing the profits of companies to their stock price and assuming that this is all there is to the equation, whole the market looks far beyond that in practice.

They are looking at price compared to this year’s earnings, one move ahead, where the market is calculating many moves ahead. Instead of viewing how the market is viewing and valuing a stock, this has them choosing to instead ignore the market in favor of their limited and dubious perspective.

A simple example of how this works would be in comparing two stocks, one that is on the decline and one that is on the rise. The declining stock may have great looking future prospects as far as business goes, and this may mean that 10 years from now they may be expected to do fairly well, but they are not doing so well now.

Another company, with the same good long-term fundamental outlook, sees its stock go in the other direction. These companies may end up in the same place in the long run, which our fundamental analysis may point to, but they sure are heading in different directions now, and this can happen even though their fundamental outlook may be similar or even with the underperformer looking better fundamentally.

Treating them the same way now would be a big enough mistake in itself, as one is clearly outperforming the other in the time frame that matters, now, but what analysts want to do often times is to assume that since the lagging stock may catch up in the long term, it is more valuable in the short term.

In reality, the difference in valuation that the market has assigned may not bode well for the analysts’ long-term views, because stocks price in the future as well, and price the future in quite a bit, but the future is not now, and the shorter-term time horizon of this analysis requires short-term guidance, not long-term.

It is not that fundamental analysts don’t look at the short term, but they put too much weight on a particular influencer of stock prices to the exclusion of other influencers, instead of looking at the sum of all these influencers, which technical analysis does.

You can use technical analysis long-term as well, but the problem is that the longer out we go, the less valid it is. An example would be riding the long-term chart of a stock index over the last 10 years, which has looked bullish throughout, but if we want to use this to decide where things may be 5 years from now, this will not even give us a good idea by itself.

We need to look at fundamentals for this because this is all we really have, things like economic forecasts as well as investor trends. It’s not that we won’t be guessing here, but it will be much less of a guess than if we just relied on technical data, which means predicting where price will go based upon how it is trending.

We then take this long-term guidance to provide some vision, and then manage our positions along the way by using technical analysis. This is much like having an idea of where we are going and then watching things unfold as we drive along the road that we’ve chosen.

Spotify’s Upgrade Has Analysts Paying Attention to What Matters More than Usual

The reason why seeing analysts upgrade Spotify here after a terrible last two months and a fundamental outlook that still looks grim to these analysts is that this not only involves a greater use of technical analysis than normal, they actually are admitting it. The stock still looks terrible we are told, but it has fallen enough that it looks oversold and looks like it might be a good trade here.

This applies their analysis in a way that is better aligned with its objectives, as it really can’tbe focused on the long term nor should it be because position trading just does not involve that. When we see forecasts from these analysts, they are not even pretending to make predictions years down the road, they are doing so in a shorter time frame than this, and technical analysis is the tool that best provides this guidance, because this is the time frame that it is focused on.

Looking at Spotify’s current chart, an actual trader might come to a different conclusion here, as it still looks pretty weak, and traders, who rely on technical analysis, seek more confirmation than just a stock continuing to decline as Spotify is. However, these stock analysts are at least showing that they are focused on the right things, where the stock may be heading based upon its chart.

You do not want to try to jump the gun with a bottom play though, as tempting as this may be to some people, and what is required here is that the stock drop a long way and stop dropping. We do have one of the two conditions met now, and Spotify sure looks like it may be oversold, but this is only potential until the market confirms our suspicions.

August and September were terrible months for this stock, and while the market itself took a dive in August, and rebounded for the first half of September at least, Spotify hasn’t taken any break and has lost 28% in less than two months.

Spotify’s extending their free trial from one month to three is what set this off initially, and if you think that markets are perfect and fully price in things at all times like some academics believe, this is a good example of how far off this view is. This should happen in an instant according to them, not over 2 months.

It is true that given Spotify’s precarious business model, which has yet to deliver anything but losses, makes it more subject to taking bigger hits than a stock normally should from news like this, but there may be some point where enough people will jump back on this horse, as they have done in the past, and that time may indeed be soon.

For example, between June 3 and June 17, Spotify put in a very nice 22% gain, and while it is virtually impossible to time these trades perfectly, a sharp trader could have noticed that the bottom on June 3 was higher than the last one and jumped on fairly close to this level, and then rode it up to capture at least the majority of this move. If you even only get half of this, 11% in two weeks is impressive enough.

Spotify may be a dog company but that does not mean that it is a dog to trade, and if the dog is one that really likes to move around, this can present some very good opportunities indeed. This involves placing shorter-term trades with it than institutional traders would, but given that we can do such things effectively, we may profit nicely from these moves.

What is really noteworthy about these analyst upgrades is that they are actually focused on swing trading, where the belief is that the stock may rise enough over the next few weeks and therefore is worth more of a look. Their rating scheme may not allow them to make actual buy recommendations based upon such an opportunity, and they have to call such things holds instead, but the dialogue is certainly aimed at a swing trade long here.

Don’t expect much of this though as they are still focused on their position trade timeframes, and are still very much committed to paying too much attention to fundamentals. Spotify looks rather ugly on this basis and time frame, and they really need to follow the road that their masters travel down. This won’t become a swing trader’s advisory anytime soon, or perhaps ever, but once in a while they may step onto this court like they just did.

Swing traders need to rely on either their own analysis or analysis specifically designed for the type of trading that they do, but it’s interesting to see fundamental analysts along for the ride with this particular play.

They are still a little too eager though, as is their nature, and Spotify has to show us more than just running in place over a period of a few days before we’d want to predict a reversal here, but this may bear close watching and may indeed provide a nice short-term trading opportunity if the market ends up agreeing enough.

Ken Stephens

Chief Editor, MarketReview.com

Ken has a way of making even the most complex of ideas in finance simple enough to understand by all and looks to take every topic to a higher level.