Problem 15 - Basic Statistics for Business and Economics with Student

Question

Suppose you recently opened an account with Ameritrade, Inc., an online broker. You have decided to purchase shares of either Johnson \& Johnson (a pharmaceutical company) or PepsiCo (the parent company of Pepsi and Frito- Lay). For a comparison of the two companies go to http://finance.yahoo.com and in the space where it says Get Quotes enter the letters JN and PEP, which are the respective symbols for the two companies. Click on Go and you should receive some current information about the selling price of the two stocks. To the right of this information click on Intraday and then click on Analyst Opinion. Here you will find information from stock analysts evaluating these stocks. Brokers rate the stock a 1 if it is a strong buy and a 5 if it is a strong sell. What level of measurement is this information? Which of the stocks would you recommend?

Step-by-Step Solution

Answer

The level of measurement is ordinal; I recommend buying JNJ.

Step 1: Understand the Exercise

The task involves assessing the level of measurement for analyst opinions on stocks and making a recommendation based on this information.

Step 2: Identify the Level of Measurement

In the exercise, stock analysts rate a stock from 1 (strong buy) to 5 (strong sell). This scale is a type of ordinal measurement since the numbers indicate a rank order, but differences between the numbers do not indicate a specific or equal magnitude of difference.

Step 3: Gather Data for Recommendation

While we cannot access the real-time data from Yahoo Finance here, typically you would compare the analyst ratings from both stocks. Assume that this information has been gathered and JNJ has an average analyst rating of 2.2 and PEP has an average rating of 2.8.

Step 4: Interpret the Ratings

Lower numerical ratings on this ordinal scale suggest a more favorable recommendation by analysts. A rating closer to 1 means the stock is seen as a better buy. In this case, JNJ, with a lower average rating, is viewed more favorably than PEP.

Step 5: Make a Recommendation

Based on the analyst ratings assuming JNJ has a rating of 2.2 and PEP has 2.8, JNJ would be the recommended stock to buy as it has a more favorable analyst opinion.

Key Concepts

Analyst Ratings

Analyst ratings provide valuable insights into how financial experts see a company's stock performance. Typically, these ratings are expressed as a numerical scale. For instance, in the stock market analysis scenario, analysts might use a scale from 1 to 5:

• 1 for a strong buy
• 2 for a buy
• 3 for a hold
• 4 for a sell
• 5 for a strong sell

These numbers tell investors whether analysts think they should buy, hold, or sell a stock. However, it's important to note that this is an ordinal scale. This means it orders stocks, but the "distance" between the numbers doesn't show consistent differences in analyst sentiment. In ordinal scales, knowing a stock rated as "2" doesn't tell you how much better it is than a stock rated "3." It simply means it is favored more than the latter. This is vital when comparing stocks since a lower number indicates a stronger recommendation.

Stock Market Analysis

Stock market analysis involves evaluating various factors that influence the price and performance of stocks. Analysts look into a company’s financial health, management, industry trends, and economic factors before giving ratings. This process helps in identifying potential investment opportunities that align with investors' goals. Several methodologies are used in stock market analysis:

• Fundamental Analysis: Involves examining a company's financial reports, earnings, revenues, and overall financial condition.
• Technical Analysis: Focuses on past market data, primarily price and volume, to forecast price movements.
• Sentiment Analysis: Analyzes market sentiment through news, reports, and social media trends.

By combining these methodologies, analysts aim to provide rounded recommendations. They don't just look at numbers but at a company’s potential for growth and market dynamics. This comprehensive approach assists investors in understanding stock values beyond surface-level prices.

Investment Decision Making

Investment decision making is a crucial process that involves choosing where to allocate funds to maximize returns. When making an investment decision, investors need to consider a variety of factors, including analyst ratings, stock price trends, and personal financial goals. Here are some essential steps in investment decision making:

• Define Goals: Determine what you want to achieve with your investments, whether it is growth, income, or preservation of capital.
• Research: Gather as much information as possible about potential investments, reviewing both quantitative data like prices and qualitative aspects such as company management.
• Assess Risks: Evaluate the potential risks involved with an investment, considering both market volatility and personal risk tolerance.
• Make an Informed Decision: Use analyst ratings and other tools to make educated choices that align with your defined goals.
• Review and Adjust: Continually monitor investments, and be ready to adjust holdings in response to market and personal financial changes.

Effective decision making is about finding a balance between risk and potential reward, ensuring that selected investments fit with an individual's financial strategy.