Wednesday, December 5, 2007

The Games Analysts Play... Why No One Ever Says Sell

Watching investors scurry like lemmings each time an analyst says boo is a bit amusing but unfortunately in can affect your portfolio. What many new investors do (as did I) was take these analyst reports as gospel. Over time, you see the games that are played and you catch on, but usually after many lessons. Myself, I like to read the "why" of a report, but other than that don't care one bit about the actual ratings unless its an outright sell (which is as rare as a dodo bird). I also take into account downgrades the week before an earnings report, because usually the only time an analyst will stick out his/her neck is when they have (ahem) "close to the vest" news (I won't go as far as to call it insider news). I also will give a lot more weight to an analyst who works for a research only firm, meaning they do zero investment banking and their whole business is providing research....

One must always remember what the motives are for analysts, and where they are in the food chain of a bank. There was a big fuss after the late 90s and all these "new proposals" were put into place to make the analyst community change to a more useful service instead of beholden to other interests within a bank. Everyone asked why is there almost never a "sell" rating?? As with all things regulatory in this country - this fuss was raised, fines (minor ones) were levied, we were told everything was fixed, and everything went back to business as usual within 2 years. I just have to laugh when I see all these sells NOW showing up for the financials... it would be amusing if the reasoning behind it were not so pathetic. Read on to learn about "business as usual"

No Sign of "Sell" on Wall Street as Analysts say "Buy" "Hold"
  • Anybody who followed the advice of Wall Street's top-ranked analysts, none of whom would say ``sell'' for a single company in the securities industry this year, is reckoning with subprime-like losses.
  • Merrill Lynch & Co.'s Guy Moszkowski, UBS AG's Glenn Schorr and Sanford C. Bernstein & Co.'s Brad Hintz maintained either buy or hold recommendations on Bear Stearns Cos. as it fell 39 percent in 2007, the most since the firm went public in 1985. Moszkowski and Hintz had buy ratings on Morgan Stanley while the stock shed 22 percent in New York trading. Moszkowski and Schorr advised holding on to Citigroup Inc. as it dropped 40 percent.
  • Shrinking fees from brokerage commissions mean fewer dollars for research and more pressure on analysts to hang on to paying customers such as hedge funds. While clients care little for ratings, they covet meetings with company executives -- audiences that favored analysts can deliver. As a result, ``sell'' ratings on Wall Street are even scarcer than four years ago, when 10 securities firms paid $1.4 billion to settle allegations by then-New York Attorney General Eliot Spitzer that they used research to improperly promote stocks.
  • ``An analyst cannot issue a sell rating because he doesn't want to lose access,'' said Tom Larsen, a former Credit Suisse Group analyst who now runs research and helps oversee $6 billion at Somerville, New Jersey-based Harding Loevner Management LP. ``It's logistically cumbersome for the buy-side to arrange its own meetings with company management, so this concierge service is very useful.''
  • Analysts rarely said ``sell'' before the Spitzer settlement because they didn't want to jeopardize investment banking fees. Now, they're more concerned about maintaining good relations with company management. Only of analysts' recommendations have been sell this year, 7 percentdown from 11 percent in 2003, data compiled by Bloomberg show.
  • Institutional investors are willing to spend more for meetings than ratings, according to a survey of money managers by Greenwich Associates, the industry consulting firm founded 35 years ago in Greenwich, Connecticut.
  • Investors ``place a pretty high premium on brokers that can do a good job coordinating access to the companies' CEOs, CFOs, treasurers,'' said John Feng, a principal at Greenwich Associates.
  • Hintz, 57, the third-ranked brokerage-industry analyst according to Institutional Investor magazine, said in an e-mail that his ratings aren't intended as trading advice and aren't influenced by any desire to mingle with company managers. ``We are not supposed to make trading calls,'' Hintz said. ``Just because a brokerage stock goes down over a short period doesn't mean it's an underperform.'' (keep that in mind the next time everyone panics when a broker downgrades from strong buy to buy; it is not meant for trading advice)
  • Instead of saying ``sell,'' analysts have stuck with ``hold'' ratings that are less likely to antagonize the senior executives they're monitoring, Larsen said. The ratio of hold recommendations has climbed to 48 percent this year from 40 percent in 2003, Bloomberg data show.
  • While a ``hold'' might be enough to signal to institutional investors that a company is in decline, retail investors follow analyst recommendations literally, according to a study published in the Journal of Financial Economics in August. (Darn retail investors.... handing money over to institutions hand over fist until they learn "the game")
  • ``Companies can live with a hold recommendation,'' said Larsen of Harding Loevner. ``The tacit understanding by everyone, except possibly the retail investor, is that it's a less-harsh way to say sell.''
  • Hintz and Schorr downgraded Merrill to hold on Oct. 25, a day after the firm announced a $2.24 billion loss. By that point, the stock had lost 32 percent.
  • Hedge fund manager Colby Harlow, who oversees more than $100 million at Dallas-based Harlow Capital Management LLC, said he only uses Wall Street research reports as a way of gathering data on the firms he tracks and never follows the recommendations.
  • ``These guys don't want to get out in front of the crowd and make a big call because if they're wrong they're out of a job,'' Harlow said. (to me this is the most important thing people need to understand - if you are an analyst and you are wrong by agreeing with the crowd, you can simply say "well everyone was wrong" - this is why they rarely, if ever, take chances)``I don't use sell-side research because I want to have some kind of edge.'' (what a quote!)
  • Analysts with the most bullish recommendations are typically the most accurate at predicting earnings, according to research by professors Shuping Chen and Dawn Matsumoto at the University of Washington in Seattle. That proves that companies provide more information to analysts who make favorable ratings, (that's fair!) Chen and Matsumoto wrote in their paper published by the Journal of Accounting Research in September 2006.
  • For analysts, the punishment for a negative rating can be as swift and unmistakable as a door slamming shut, said Richard Bove, a Lutz, Florida-based analyst at Punk, Ziegel & Co., who downgraded the top five U.S. brokers to ``sell'' in July. ``At one of the companies I've been writing very negative things about for a while, the CEO absolutely refuses to talk to me anymore and I don't have access to that management,'' Bove said in an interview, declining to identify the executive. ``And if you lose access to management, you lose the ability to take them on the road and that reduces your commission income.''

And this folks, is why most retail investors lose their shirts the first few years of investing....

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