Finance: Ignoring the Analysts
Saturday August 4, 12:12 pm Eastern Time
By Linda Stern
WASHINGTON (Reuters) - So the word is out: Analysts can't be trusted. Those Wall Street eyeshades who pronounce some stocks as ``buys'', others as ``holds'' and far fewer as ``sells'' are discredited by varying levels of incompetence, interest conflicts and corporate pressure.
Organizations as diverse and weighty as the Securities and Exchange Commission, the Association for Investment Management and Research (the analysts' own professional organization), the National Association of Securities Dealers and Merrill Lynch (which employs more than a few top dollar analysts of its own) have agreed that there are some problems with all of those pronouncements.
Sometimes the problems are severe, and unethical. The SEC recently found that almost one in three analysts were recommending companies they had already invested in themselves.
Analysts may be paid more if their recommendations lead to an investment banking deal with the company they are analyzing for their own brokerage firm. Even in cases where such clear conflicts exist, analysts work in a system that puts all of the pressure on the buy side.
Brokerage firms and indeed investors are happier with ``buy'' recommendations than ``sell'' calls, and the analysts themselves work so closely with the companies they cover that they sometimes lose their objectivity.
``Analysts come to the table looking through rose-colored glasses,'' said Charles Hill, director of financial research for Thomson Financial/First Call, a company which surveys the analysts.
At the height of the bull market in early 2000, ``buy'' recommendations were running 100 to 1 against ``sell'' recommendations, he said.
``There were too many (analysts) whose work was shoddy and/or biased because of naivete, laziness or outside pressure,'' Hill said.
Add to all of those problems one more: the earnings figures by which analysts (and the stocks they cover) rise and fall are becoming less meaningful.
Companies, and in particular high tech companies, can monkey with their earnings by selectively excluding or including items that don't necessarily fit in the earnings report. They can lump together losses, create phantom value for intangibles, and report earnings of their own design that they then call ``pro forma'' or ``cash'' earnings, said Hill.
At the same time, there's been growing market dependence on so-called ``whisper numbers'' -- unofficial earnings estimates that the analysts may not be able to track but may feel pressured to match.
Just because all of this is now discussed openly in Washington and on Wall Street doesn't mean it's going to get better soon.
Some companies, like Merrill Lynch and Credit Suisse First Boston, have started policing themselves, and the SEC seems content to let them do so a while longer, without any new rules to keep them on the straight and narrow. Congress may be holding hearings on the subject, but isn't on the fast track to legislate the problem away, either.
So, as usual, individual investors must protect themselves. Anyone who gets recommendations from a broker should, at a minimum, make sure that the brokerage firm in question doesn't underwrite securities for the companies it is hawking.
It's better to go even farther and insist that the reasons for the recommendation are spelled out. What are the company's real (not pro forma or subjective) earnings? What is it that the analyst sees in this company? Is the share price, when compared to the company's earnings, earnings growth, book value and cash flow, a reasonable one?
It takes a lot of brains and a lot of education to make an analyst. They're not stupid, and the vast majority of them aren't crooked either. But they're working in a system that's a little bit bent and they're under pressures that can bend them even further.
Until all of that gets straightened out, it makes more sense to find other reasons to choose one stock over another. |
