Second Guessing Sell-Side Analysts: When Does "Buy" Really Mean "Buy" -- If Ever?
February 9, 1999 - 7:40 PM
By Steve Kimian
- Chat with Steve on his message board.
To turn an old riddle on its head, if a securities analyst speaks and others hear him, did he really say anything? Or – more to the point – how can you tell the difference between what sell-side analysts say, and what they really mean?
The reality is that most sell-side analysts – the people at brokerage houses who make stock recommendations that can make or break a stock (or your portfolio) – only occasionally decide whether a particular stock is a “buy” based on what they think will be the direction of the stock's price.
In the world of brokerages houses, when an analyst says a stock is a “buy”, it may well means that:
Everyone and their mother already cover the stock, and they all have a “buy” on the stock. The analyst isn't about to do get his hands dirty trying to figure out whether everyone else is right – so it's a lot easier to go with the flow. It's a lot more difficult for the poor slobs who follow the analyst's advice to get mad, too, if every other analyst was wrong, too
The firm the analyst works for recently did some investment banking for the company in question, and needs to support the stock price – so that the guys who the salespeople (sorry, “account executives”) were able to flog the stuff to might conceive of coming back next time.
The firm the analyst works for wants to do some investment banking for the company in question, or for other companies in the industry, and wants to show how the firm supports investment banking clients by hawking the stock, regardless of the actual quality of the company.
The prop desk (proprietary trading desk – that is, the people who buy and sell with the firm's money, not that of clients) needs to unload a big position, and would like to do it as profitably as possible.
The asset management arm of the firm the analyst works for is holding a ton of stock, and desperately needs to unload some of it and/or goose the price a bit, so that quarterly performance numbers won't be as abysmal as those of the previous quarter.
Previously the analyst had a “strong buy” on the stock. The analyst somehow learned that the company is in the process of imploding. But everyone knows you can't go from “strong buy” to “hold” overnight without killing the stock's price – so you downgrade instead.
Generally, analysts are in business for no one but themselves, and if some poor idiot happens to take their investment advice seriously – well, sorry, buddy, you should've known better.
Most analysts are too busy figuring out how to brighten their halo of expertise, make friends with the CFO at that hot start-up, and get their research assistants to hurry up with that latest 90-page monthly industry update, to really think about whether a company's stock is going up or down – not that it really matters to them anyway.
Stock picking isn't what matters for most analysts. Many brokerage houses make money through doing investment-banking deals and through trading volume – which is, by the commissions and spreads from purchasing and selling stock. It's more likely that they'll make money by telling clients to buy – where's the benefit to telling investors to “hold”?
It's not a coincidence that of the total number of recommendations issued by brokerage houses in the United States, the vast majority are buys – and less than 5% are sells. Since for every buyer there must be a seller, what does this tell you about what's really going on?
More often than not – unless you have insider information and are willing to break the law, which is another story – a “buy” doesn't mean you should buy. This is especially true for Joe Q. Investor. Small investors are the last to know anything – and only after institutional investors have made their money anticipating what the little guy will do (over time, thanks in large part to the Internet, this is changing, of course; but in the meantime, it still holds true. Mutual funds and hedge funds make their returns by selling stock to small investors who are behind the curve.)
One answer to the conundrum of how to listen to analysts is to ignore them altogether. Another answer, though, is to heed the signals, and play savvy. For example:
Not every brokerage house does investment banking. Listen to those analysts at houses that could care less about investment banking mandates – they may be more likely to focus on picking stocks that are moving in the right direction, and on making money for their clients.
Keep track of which brokerage houses rely heavily on investment banking for revenue (hint: it's probably those that make the most noise about how great their research is), and take their research with a grain of salt. The firms looking to take public hot .com IPOs are liable to be very even-handed in their analysis of the market.
Be on the lookout for events open only to institutional investors that may impact the price of a stock you hold. If a brokerage house is hosting a big sector- or industry-specific conference, featuring company and analyst presentations, be wary – information may be exchanged that could lead to a mysterious but all-too-real downdraft in stock price. Companies and analysts often inhabit a gray legal purgatory during these conferences, and it's the small investor who is the most likely to suffer.
In the final analysis, the best advice is to be your own analyst. Keep on top of the market, the company, the sector, and the competition. Chose what you want to focus on, and know it well. Don't be afraid to use the valuable information you learn. If your buddy at the local computer shop comments that sales of product XYZ are slowing down, sell now, before a not-so-friendly analysts figures out what every stockroom guy in the country knew weeks prior, and downgrades the stock.
Sure, doing it yourself is a lot of work, but it's your money. Day trading, for most people, won't keep the portfolio growing forever – bona fide brain power, not gut reactions and tea-leaf reading, is the real recipe to long-term investment success.
Analysts and their irritating talking heads come and go, but an investment decision based on insight developed the old-fashioned way is more likely to pay off regardless.
|
