Are Analysts Really Necessary Anymore?
Given the recent surge in the market, particularly the Semiconductors, I think it is time to revisit the sometimes- confusing actions of equity analysts. Recall our conversation just over a month ago where we highlighted the fact that this group of supposed experts is frequently wrong. The conclusion I drew at that time was that we, as individual investors, can do just as well (perhaps better) by doing our own research without paying attention to the noise coming from the analyst community.
One of the important factors that has tilted the scales of justice in our favor is the change in the communication channel between publicly traded companies and individual investors. In the past, most of the meaningful information flowed first to analysts, who then filtered the information before passing on to the individual investor what they thought we needed to hear.
With the introduction of Reg FD (or Regulation Full Disclosure), companies are no longer able to have private analyst meetings, hidden from the public eye. Instead, any information made available to the analyst community must also be made simultaneously available to any investor with an interest in the news. What this means is that we truly do have just as much information about what is going on with a given company as any analyst. What remains an open issue, is whether we have the ability to interpret the information and form an actionable plan.
With the wealth of educational resources available, from books on both technical and fundamental analysis, educational seminars, a plethora of financial websites, and advanced computer software, the arsenal of tools at our disposal is truly staggering. The only remaining question is whether we are willing to invest the time and money necessary to build our own education. Rather than rely on self-proclaimed experts, I am far more comfortable knowing that I can look at all the technical and fundamental information available to make my own investing decisions.
Analyst ratings can provide good information for us as well, but we must determine which analysts provide prescient information and which ones are behind the curve. Just as we know that the majority is often wrong, the majority of the analyst community seems to be on the wrong side of the market, especially near major turning points. If we can determine those analysts who seem to be at the leading edge of market moves, this can provide a valuable tool for our investing decisions.
Coming back to the Semiconductor sector, I think this group makes a great case study of the majority of analysts failing to see the coming changes in the group of stocks on which they are supposed to be the experts.
The Semiconductor sector is best measured by looking at the Philadelphia Semiconductor index (SOX.X), and there is no denying that this sector has been in a sustained downtrend for several months now. While the majority of industry analysts were lined up on the Buy side, John Joseph of Salomon Smith Barney made a controversial call last summer, downgrading the entire sector. Hindsight being what it is, we can look back and see that he provided excellent advice for investors in stocks such as Texas Instruments (NYSE:TXN), Intel (NASDAQ:INTC), and Applied Materials (NASDAQ:AMAT), all of which proceeded to decline 50-75% due to a dramatic slowdown in the industry.
As the Semiconductors continued to decline over the past 6 months, one analyst after another relaxed their positive bias and by the end of March, 2001 most had aligned themselves in the bears' camp, expecting the fundamental picture to remain negative for some time to come. As the SOX.X declined to new yearly lows in early April, they were looking pretty good. That is until Mr. Joseph showed up last Thursday with another controversial call. Citing that the industry had reached an important cyclical bottom, he upgraded the entire sector to Outperform only days after the SOX.X bounced for a second time near the 455 level. Additionally, Mr. Joseph upgraded specific firms such as TXN, INTC, Micron (NYSE:MU), AMAT, KLA-Tencor (NASDAQ:KLAC) and Xilinx (NASDAQ:XLNX) to Buy.
So where do the majority of other analysts sit on this issue? Let's take a look. Merrill Lynch rates the companies as follows: INTC-Accumulate, TXN-Accumulate, MU-Neutral, XLNX-Accumulate, and KLAC-Neutral. That doesn't sound particularly positive, now does it? Let's look at the ratings from another big-name firm. Banc of America Securities isn't a big fan of the sector either with ratings on the same chip companies all sitting at a lukewarm Market Perform.
I could list a dozen other examples, but suffice to say that the majority of analysts are still lined up on the Sell side, or at least not in the Buy camp. Mr. Joseph is once again out in front of the crowd, and only time will tell whether he is once again correct, or if this will prove his own fallibility.
Since Mr. Joseph's broad upgrade last week, we have had positive earnings surprises from several Chip companies like TXN and INTC, helping to lift both the NASDAQ and the SOX indices. Sure, the Federal Reserve did its part today, surprising investors with another 50 basis point rate cut, but the important thing is the magnitude of the move on the SOX. While the NASDAQ advanced more than 8%, the SOX was up a whopping 12% today, demonstrating impressive strength relative to the broader Technology market.
Oh, this just in. Banc of America upgraded INTC to a buy today. If they are coming to the chip party that Mr. Joseph started, perhaps it is an early confirmation of a bottom being formed in the chip industry. Of course it will take time for his reliability to be proven, but the outcome of this nascent rally in the SOX will go a long ways towards building his reputation as a leading indicator of the health of Semiconductor stocks.
Picking a bottom (or a top) in a market, sector or stock is not easy. It takes a lot of work, and broader market forces can still act to undermine the validity of your research. All we can do is our own due diligence, and factor in the ratings of any analyst that happens to have a history of leading the pack. There are very few analysts that fall into this camp, but if last week's lows on the SOX hold, Mr. Joseph will be joining the short list of professionals that I pay attention to in my investing decision process. Who knows? Maybe I just found another indicator that I can rely on; at least for investments in Semiconductor stocks.
Prescient analysts are not limited to the Semiconductor stocks, but it takes work to ferret out who is worth listening to. Pay attention to what they say, but more importantly to what the stocks they cover do after the upgrade/downgrade. Until you can identify strong positive correlations between the best analysts and the stocks they cover, remember to trust yourself and rely on your own research. Nobody will apply the diligence you will apply in making decisions about investing with your own money.
Mark Phillips
www.armsinsider.com
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