YOU CAN'T ALWAYS TRUST THOSE ANALYST REPORTS
By Mark D. Fefer
February 22, 1993
(FORTUNE Magazine) – How far should management go in pursuit of positive reviews by Wall Street? In the case of Ferrofluidics, a New Hampshire maker of magnetic liquid products, there's apparently no limit. Hungry for coverage by security analysts, in 1992 Ferrofluidics hired an independent analyst, Sheldon S. Traube, to write a report on its operations and prospects. The report was, to put it mildly, optimistic: It forecast a nearly 20-fold increase in operating profits from 1992 to 1996. To all the world, the bullish report did not come from Ferrofluidics or its agents but from Dickinson & Co., a Des Moines brokerage firm. It was printed on Dickinson stationery and looked like thousands of other research reports. After speaking with Traube, who gave no hint of his financial arrangement with Ferrofluidics, FORTUNE cited the favorable findings in its 1993 Investor's Guide. Thanks to a tip from a reader, FORTUNE soon learned of Ferrofluidics' ties to the analyst and the firm. After some vaguely worded denials by Ferrofluidics executives, they acknowledged that a financial relationship did exist and that Traube had been paid $1,500, plus expenses, in cash. Another $6,711 was paid to Dickinson for printing and distribution costs. Traube and a Dickinson spokesman have refused to confirm that they were paid. Security analysts must live with conflicts of interest. A brokerage firm may hold an investment in a company that its analysts are evaluating, or it may even be short-selling the stock. Under securities industry rules, brokers are required to disclose material financial ties to a company that they are evaluating. But Dickinson's report said only that Traube was paid ''cash'' for his services, not who was paying him. All of which begs the question: How promising are Ferrofluidics' prospects? Traube insists that his report is an objective assessment. Other analysts who follow Ferrofluidics say the company's prospects, while good, are not nearly so stellar. Traube's high hopes are pinned on Ferrofluidics' magnetic-fluid technology, originally developed for NASA as a way to keep fuel flowing in a gravity-free environment. In its commercial form the liquid is used primarily as a sealant on such products as disk drives. Its most promising application, contends Traube, is on the pumps and valves of oil refineries and chemical plants, where it can reduce hazardous vapor emissions. Restrictions growing out of the Clean Air Act will gradually require companies to limit these emissions, and the Ferrofluidics product appears the most effective way to do so: It reduces leakage to practically zero. But since the law doesn't presently require zero leakage, it's unclear how quickly a market will develop for Ferrofluidics' sealants. Notes Daniel R. Murphy, a vice president at Brenner Securities in New York: ''The oil industry has a history of not doing anything before they have to. They'll move as fast as they're forced to move.'' Murphy expects the company to show a 150% increase in revenues by 1995, with earnings per share reaching $1.93, vs. last year's $0.83. That's still far below Traube's 1995 earnings forecast of $3.08 per share. Oakes Fitzwilliams & Co., a securities dealer based in London, is even more reserved. It expects Ferrofluidics to earn about $1.30 per share by 1995. One thing seems certain: Even using the more conservative estimates, this company should get good reviews without having to buy them |
