Ratings are important but who's doing the rating can be just as important as the score
itself.
In the world of fine dining, the most influential reviews
come from a tire company.
The French tire company, Michelin, first created a travel guide back in 1900, when there were
less than 3,000 cars in France, and travelers needed a way to find gas stations, hotels,
and restaurants.
Soon, Michelin expanded their guide to cover other countries.
The guide was free until 1920 when André Michelin saw copies of the guide being used
to support a workbench in a garage.
After that, Michelin started charging seven francs per guide because, as Andre supposedly
said, Man only truly respects what he pays for.
The restaurant reviews in the guide were becoming so popular that Michelin began recruiting
inspectors to anonymously review restaurants.
In 1926, they first introduced the star system, and by 1931, they published criteria for its
ratings: one star was very good, two stars was worth a detour, and three stars were only
awarded to restaurants worthy of a special journey.
Receiving a Michelin star can make a restaurant the place to be and higher demand means
that restaurants can charge higher prices.
One study found that earning one star increases restaurants' prices by nearly 15%,
two stars increases prices by 55%, and three stars increased prices by 80%.
Other research also suggests that reputable reviewers have more power over restaurant
prices than average reviews.
One study showed that a Yelp rating increase of one star led to a 5% to 9% increase in
revenue.
But elite Yelp reviewers had twice the impact of regular Yelp reviewers.
The power elite recommendations have over price isn't just limited to the world of
dining.
There's actually a similar phenomenon with stocks.
Each quarter, analysts publish reports about various stocks, ETFs, and mutual funds.
Think of them as the restaurant reviews of the stock market.
Analysts examine financial statements, historical data, and current market trends to make a
prediction about a stock or fund's future performance.
They're typically employed by an investment bank or independent research company, and
due to the demands of the job, most analysts only report on one or two stocks at a time.
They publish detailed reports and summarize their findings with a rating.
Some use terms like buy, hold, or sell.
Others use outperform, which means they believe the stock is likely to perform better
than the broader market, whereas underperform means they believe the stock is likely to
perform worse than the market.
Some use a scale of one to five stars; others may use a number system.
Sometimes, analysts can change their opinion based on new information that impacts a stock's
future outlook.
Like if sales are increasing, they may change their opinion from hold to “buy.
While these changes could shift public perception of a stock and, in theory, cause its price
to fluctuate, researchers found that very few analyst recommendation
changes are influential enough to significantly affect a stock's price.
Recommendation changes from star analysts those ranked as All-American in Institutional Investor
magazine are more likely to be influential.
And unsurprisingly, there are certain analysts who are leaders, meaning, if they change
their recommendations, so might other analysts.
Other research suggests that like regular investors, even analysts have a tendency to
herd, meaning, they follow what others are doing.
So if an analyst's recommendation has changed, understand the rationale behind it.
Just how you might not want to rush to a restaurant just based on its number of stars alone take
the time to actually read the full review.
An analyst's recommendation is more than just a buy or sell label.
The true value of analysts is that they can offer context to help you make decisions for
yourself.