How to Downgrade? Merrill Analysts Take a Class
New York, March 22 (Bloomberg) -- About 100 Merrill Lynch &
Co. stock analysts went to class today for a lesson on how to
lower ratings on the companies they cover without alienating
corporate clients.
In the first bear market in almost two decades, they may be
doing a lot more of it.
``Downgrading stocks is among the toughest challenges facing
analysts,'' says a March 15 e-mail from Eric Hemel, deputy head of
U.S. equity research, to the rest of his department at the biggest
U.S. brokerage. The e-mail invited employees to a session called
``Managing Investment Downgrades.''
Research analysts at Wall Street firms avoid publicly
lowering their view on the companies they cover. Their investment
banking units earn fees offering merger advice to and selling
securities for those clients. When a chief executive is unhappy
with a recommendation, he may take his business elsewhere.
J.P. Morgan Chase & Co.'s head of European research last week
told analysts they must get comments from investment bankers at
the firm and from companies before changing recommendations.
``The timing has nothing to do with the J.P. Morgan
decision,'' Hemel said in an interview.
Opinions Lag Market
Analyst recommendations have barely budged as stocks
plummeted from their peaks in early 2000.
In March 2000, about 72 percent of the recommendations on
6,000 stocks tracked by First Call/Thomson Financial advised
buying. Almost 27 percent of recommendations counseled holding and
less than 1 percent suggested selling a given stock.
The Nasdaq Composite Index has since plunged 64 percent from
its record on March 10, 2000, the Standard & Poor's 500 Index has
fallen 27 percent and the Dow Jones Industrial Average 15 percent.
About 69 percent of recommendations still suggest buying, 30
percent suggest holding, and 1 percent advise selling, according
to First Call/Thomson Financial.
Merrill has cut the ratings on 348 stocks in the past 12
months, 152 of them technology companies, according to
Marketperform.com, a Web site that tracks recommendations.
``It's a problem with the Street. Clearly, we all know it
is,'' said Geoffrey Hance, an analyst at Northern Trust Corp.
``There are so many young people they haven't been through a lot
of bear markets, or even one bear market environment.''
More Cuts
Suggesting that more cuts may be on the way, Hemel and the
panelists at the seminar covered how to ``position downgrades,
especially on previously favored stocks, vis-a-vis'' Merrill's
salespeople and pension, mutual and hedge fund clients.
The seminar was a third in a series of ten that head of U.S.
equity research Deepak Raj and Hemel, planned about three months
ago.
``The series was prompted by our perception that internal
training was a good thing, and we should do more of it,'' said
Hemel. ``Had this been two years ago, we would have had the same
topic. It's a fundamental issue in being an analyst -- in good
times and in bad.''
The topics covered, according to Hemel's email were:
``Working through the psychological barriers'' to downgrading a
stock, such as having ``persuaded investors previously to buy the
stock at a higher price'' and handling ``the diplomatic aspects of
downgrading so as to preserve as much as possible one's access to
company management.''
Also on the seminar's agenda was ``when NOT to downgrade
stocks,'' according to the e-mail, ``even though doing so many be
the `easy way out.''' That might occur when ``the company's
fundamental trends proving disappointing but the company's current
stock price discounts or excessively discounts these
developments,'' the e-mail said.
Hance said the lessons on downgrading are ``a little late.
From the timing standpoint it's a little embarrassing. But I think
it's important that they impress upon their analysts that one of
the value-added services they're supposed to be providing is a
little more objective guidance, including making negative calls.''
Teachers
Merrill has topped Institutional Investor magazine's annual
list of firms with the most highly ranked stock research analysts
for six years.
The seminar panelists include seasoned analysts who made that
list at least since 1998.
Lauren Fine, who covers publishing, lowered her
recommendations on Gannett Co. and True North Communications in
the last six months. Jerry Labowitz follows electronics and
component-makers and cut his ``near-term'' recommendations on
CommScope Inc., Belden Inc. and SCI Systems Inc. to ``hold'' from
``buy'' early in March.
Merrill's John Casesa, who covers automakers, last month cut
his ``near-term'' rating on Magna International Inc. to ``hold.''
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