Nov. 26 (Sunday Business/KRTBN)--Imagine a racing tipster who says he has
sound reasons to avoid betting on a particular horse -- only he does not pass on
his advice until after the race is run. There probably would not be much demand
for his services, especially if he had told punters before the race that the
horse was a sure thing.
But if he put on a sharp suit and tried the same tactics in the City or on Wall
Street, he would be called an analyst and be paid a huge salary for his wisdom.
Rating the investment prospects of stocks must be a very difficult job. Even so,
analysts at investment banks and brokerages have demonstrated some errors of
judgment in the past few weeks that are nothing short of spectacular.
In particular, they have displayed an uncanny knack for maintaining glowing
opinions of companies they follow, even as their share prices slide, then
lowering their ratings only after the companies have reported horrific news and
their shares suffered cataclysmic declines.
In the most notorious recent example, Intel announced, after trading closed on
21 September, that revenues would grow by less than the market had expected. The
announcement prompted a number of top-class brokerages, including Deutsche Bank
Alex Brown, Salomon Smith Barney, ABN Amro, Prudential Securities, Morgan
Stanley Dean Witter and Chase Hambrecht & Quist, to downgrade the stock.
But by the time their clients could act on their advice -- when trading resumed
in the next session -- the stock was below $50 compared with about $61 before
the announcement.
In the few days that followed, Eastman Kodak, Apple Computer and Lexmark
International Group, a maker of laser printers, shocked investors with their own
after-hours announcements anticipating weak results. Analyst downgrades
followed, but again too late; all three stocks went down when trading resumed.
"They are bright, talented people, but their recommendations don't count for
much," a senior fund manager at a London portfolio-management company said of
the analyst fraternity.
As bright and talented as they are, why are analysts who follow well-known
companies for large, respected brokerages apparently unable to anticipate
downturns in performance so great as to knock 20 percent to 50 percent off share
prices?
The American research director at one of the world's largest fund-management
companies offered an answer: "They don't anticipate events because they're not
paid to. They're paid to make their investment-banking clients happy. Intel
analysts didn't do anything that any other sell-side analysts don't do."
Brokerage analysts are routinely referred to as "sell-side", an allusion to the
fact that the way their employers make money is not from market advice but from
fees from investment banking -- putting together merger deals and stock and bond
issues. It is commonly thought outside the industry that analysts are loath to
issue sell recommendations for fear of losing investment-banking business.
Brokerages insist this is not so, but they do sometimes concede a fear of being
too harsh and losing access to corporate executives who provide information that
could give analysts greater insight. When a company issues a profit warning, it
gives analysts a green light to downgrade the stock when they otherwise might
have been reluctant to offend.
This fear could also explain the frequent occasions when a leading analyst
downgrades a stock without the benefit of a chilling corporate announcement and
other analysts follow suit swiftly.
"The fear of being denied access to corporate execs or losing investment-banking
clients influences their opinions," said the American research director, who
insisted that neither he nor his firm be named. "Does it affect the way they
analyse? Maybe at the margin."
Whatever the reason, sell recommendations are extremely rare, he pointed out,
and this is why he finds analysts of little use.
"Ninety-nine per cent of stocks are rated either strong buy, buy or hold," he
said. "Even if you re-rate that to buy, hold or sell, you still are over 70
percent buy and hold. With 12,000 public US companies, do you really think they
help me to build a portfolio of 50 stocks?"
Salomon Smith Barney's technology analysts did little to keep investors out of
MyPoints. com. Earlier this month they cut their rating on the online media
concern when the stock was clinging grimly to $2 a share, down from its high in
January of about $70. The old rating was "buy". The new one? "Neutral."
MyPoints.com is one of several obscure tech companies cited by James Stack,
editor of the American newsletter InvesTech Market Analyst, that were downgraded
only after their share prices sank dangerously close to zero -- but clients were
never advised to sell.
"Across the hallowed halls of Wall Street, analysts are scrambling to downgrade
their recommendations of individual stocks," he said.
"But ever fearful of losing their inside contact or driving the next
venture-capital deal away from their firm, no one wants to use the S word.
Instead they devise every form of ambiguity imaginable to avoid stepping on
toes, but in the end still look like idiots."
In addition to MyPoints.com, Stack mentioned 24/7 Media Inc, Imax Corp and WebMD
Corp. All had fallen more than 75 percent from their peaks and, at the time the
newsletter was published, MyPoints.com had "lost 97.7 percent without receiving
a single sell recommendation. Amazing, simply amazing".
Such awe seems to be inspired mainly in the US, but it is the result not of
excessive ineptitude so much as the extraordinary amount of data gen- erated. If
Wall Street seems to spawn so much poor analysis, it is because so much analysis
is done there.
The sport of estimating earnings and issuing share-price targets is rarer here
in the UK, so there have been fewer Intels, but there could be some Intels
waiting to happen. The London fund manager mentioned earlier, who also insisted
on anonymity, pointed out that the consensus among the 10 largest City brokers
is that Vodafone will trade at UKpound 4 a share within 12 months, a 60 percent
gain from its recent price of UKpound 2.50. The same houses on average forecast
a rise in the FTSE 100 of less than 10 percent .
"It's possible both will happen, but it's unlikely they will happen at the same
time," he argued. "It's a ludicrous situation, isn't it?" He cited the same
reason behind it as the American research director: "They are not giving
independent advice; they need to retain corporate clients."
Hugh Young, managing director in Asia for Aberdeen Asset Management, expressed
the same disdain for analysts in that region and for the same reasons.
"We do our own research because we are wary of analysts," he said. "The major
reason is that traditional secondary stockbroking makes no money. All the money
is in investment banking and the promotion of new share issues. So although
still called analysts, these people are often share promoters and marketers,
paid not for the accuracy of their advice but for the fees they generate."
Citing some notorious recent examples of Asian stocks knocked hard by shockingly
poor corporate performance, he said: "I cannot remember a single analyst
cautioning on Pacific Century Cyberworks, Softbank or Hikari Tsushin. The
emperor indeed had no clothes, but he was paying the bills."
The same potential for conflict exists in Europe, perhaps more acutely than
elsewhere.
"In Europe we're having record levels of IPO and M&A activity," said Raj Shant,
director of European equities at Credit Suisse Asset Management in London.
Because profit margins in arranging mergers and acquisitions and flotations are
typically 10 times those in conventional stockbroking, he said "most major
houses tend to struggle to put out really bearish research notes on companies
where there are prospects of juicy corporate activity down the line. It's
straightforward economics; there can be conflicts of interest".
He then presented "the case for the defence". Noting that Intel's brains trust
apparently was caught off guard by weak revenue growth in Europe just as much as
Wall Street was, he said: "At the end of the day, it is unreasonable to expect
market analysts to know companies better than the companies' executives do."
He also observed that "over the past couple of years the quality of analysis has
improved dramatically in Europe", in large part because companies have been
compelled by regulators to disclose more information. European research, he
said, "is probably still not the best in the world, but it's improving".
If regulators are given part of the credit for improving European research, they
get part of the blame for the deficiencies in the US.
The American research director noted that in the interest of stamping out
insider trading, agencies such as the Securities & Exchange Commission have made
it harder to obtain corporate information.
"Analysts are behind the curve because they only have access to public
information," he said. "Research used to be about finding insights about the
company. Now the company has to tell everyone the same thing at the same time.
Sell-side analysts have turned into reporters, not analysts."
He advised investors to listen to what analysts say but not to follow their
recommendations. "Don't put a lot of faith in their opinions. They tend to know
their industries well, and a few of their companies, but I don't put much faith
in their skills at stock-picking. Use them to get educated. Use their
projections on earnings to understand what the market has priced in. That's
about it."
He then tossed around ideas for overhauling the analysis business to make it
more objective and less prone to conflict.
"Get the SEC not to allow investment-banking firms to have their own analysts,"
he suggested. "I don't know, but since I am a buy-side analyst, I guess I am
biased as well."
By Conrad de Aenlle
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