Analysts' Links to IPOs Mean
Losses for Investors, Study Finds
By RAYMOND HENNESSEY and LYNNETTE KHALFANI
Dow Jones Newswires
Investors have long known they have to take Wall Street analysts' stock research with a grain of salt.
But they might consider swallowing a whole ocean when it comes to a recommendation about a company for which the analyst's firm did the IPO-underwriting work.
According to data over a four-year period from Investars.com, an online investment information service, investors lost an average of 53.34% when they followed the advice of an analyst employed by a Wall Street firm that had led or co-managed a particular stock's initial public offering of stock. By contrast, investors lost just 4.24% when they took the suggestions of analysts whose firms had no underwriting relationship with the companies researched.
Both results are poor. What is striking is the disparity between the performance of stocks promoted by analysts whose firms have something to gain -- namely, lucrative underwriting fees -- and other, nonaffiliated stocks. In many ways, the Investars data further quantify what many investors have believed for some time: The so-called Chinese Wall that is supposed to separate a firm's analysis and investment-banking business has cracks.
"We have analysts come through here all the time, and we know to be careful," said David Klaskin, a money manager and president of Oak Ridge Investments in Chicago. "The overall quality of research isn't good."
Still, savvy investors often know that there is a subtext to many analysts' ratings, particularly when the firm is trying to protect an investment-banking relationship, Mr. Klaskin said.
Also, some investors can bypass analysts' coverage altogether: Larger institutions have their own industry analysts, while midsize and small firms often pick a handful of analysts they trust and use them, ignoring others. But for the average individual investor, buying such advice usually isn't an option. "It's caveat emptor," says longtime market observer and Harvard University Professor Samuel Hayes.
There are also some caveats about Investars's findings. The company's conclusions are based on a hypothetical portfolio to show how much an investor would have made or lost following Wall Street's recommendations. Investars committed various amounts of money based on the strength of a firm's recommendation. An "Outperform" rating, for instance, generated a $200,000 investment, while an "Underperform" rating resulted in the portfolio shorting the stock by $200,000. Also, some days and price moves aren't reflected, because Investars only tracks performance from when research is issued. So, for example, a first-day price pop for an IPO would be excluded, since analysts don't typically generate research on new public companies the day they make their debuts. Another factor: Investars employs an eight-category rating scale -- from Strong Sell to Very Strong Buy -- as opposed to the five-tier system used by other services like Thomson Financial/First Call.
As a result, Investars's results might be skewed, according to First Call Research Director Chuck Hill. He said it is widely understood that analysts' recommendations are inflated.
Investars CEO Kei Kianpoor said his firm didn't try to read between the lines of analysts' picks. "We take [investment] banks at their word. If they say buy, we assume that means buy," Mr. Kianpoor said. "The average investor shouldn't need a degree in deconstruction and semantics to understand what these banks are saying."
Investars President John Eagleton insisted his firm's data weren't meant to bash analysts. "We think the best research still comes from Wall Street." he said. |
