Brokerage analysts analyzed - and it ain't good:
From SmartMoney smartmoney.com
WE NOW KNOW the truth about the performance of Wall Street analysts, and it's worse than I would have dared to think.
Investars.com launched a new investment Web site last week with a fascinating analysis of Wall Street research recommendations. Hypothetically buying on every upgrade and selling on each downgrade since January 1997 to the present, Investars compiled returns for 19 firms covering the entire universe of stocks followed by research analysts, in itself a staggering exercise in data processing.
Over the same period (through last week), the S&P 500 gained about 75%. The best of the Wall Street firms — Credit Suisse First Boston — managed a return of just 7.63%, a breathtaking level of underperformance that should have every client who follows such research flocking to an index fund.
How could this be? How could so much highly paid "talent" be so wrong?
Investars hypothesizes that it's because of the conflicts of interest that arise when the Wall Street firms act as investment bankers to the companies their analysts cover. The resulting bullish bias is a problem, no doubt, but I'm not sure it explains this level of underperformance. A bullish bias should be a boon in a period when the S&P rises 75%. I suspect the cause is the herd instinct. This isn't the fear of being wrong — on the contrary — but the fear of being compared unfavorably to other analysts. If you make a mistake, even a serious one, your career as an analyst will suffer only if your peers at rival firms disagreed with you and made the right call.
That's one reason, I suspect, that the overall returns don't differ that much among firms. Only four earned positive results, and the 10th-ranked firm, Bear Stearns, produced a return of -3.8%, a little over 10 percentage points behind Credit Suisse. The herd instinct, unfortunately, leads analysts to issue upgrades when stocks are at market highs, and downgrade them when they are at or near market lows. That, of course, is a recipe for a disaster of the magnitude Investars documents.
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