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No one ever went broke ignoring the analysts
Everyone's got an agenda. Yours is to make money. And the brokerage experts who recommend you buy, hold or sell a stock? Who knows?
By Harry Domash
Cheyenne, one of our Start Investing Community regulars, posted a thread recently expressing her amazement that an analyst had actually recommended selling a stock. That morning, Merrill Lynch had issued a "sell" on Ciena (CIEN, news, msgs), indicating that the stocks fair value was $5.30. Ciena was trading at $9.48.
There are probably two kinds of people reading this. One is saying: What in the world is she talking about? The other is thinking that picking on securities analysts right now is a little easier than shooting fish in a barrel.
For the beginning investor who is trying to understand the mystery of Wall Street: A securities analyst is a person who evaluates stocks, usually in a specific sector of the market like energy or chemicals or drugs.
When we talk about analysts, we usually mean sell-side analysts, who work for big investment firms like Merrill Lynch, Salomon Smith Barney, Morgan Stanley Dean Witter. Their job is to report to the firms clients the outlook for stocks in their sector. Analysts write reports on the prospects for specific companies and forecast earnings estimates for them. Their reports and forecasts can move the market, so we need to pay some attention. But not much.
Analysts once respected
Years ago, when I was a reporter on the business desk of various newspapers, we revered analysts. A Wall Street magazine called Institutional Investor does an annual ranking of analysts called The All-Star Team, naming the top analysts in each industry. To us business reporters, it was a bible.
We considered analysts to be the smartest, most objective source of information available on a company. For instance, I covered the chemical industry in Delaware, and so I knew a fair amount about DuPont (DD, news, msgs). But when DuPont proposed a merger with Conoco (COC, news, msgs), I needed to get up to speed quickly on the energy industry, so I whipped out my All-Star list and started calling energy analysts.
Lots of investors still view analysts the way I did back then, as a source of fresh, unbiased information about a company. They look at analysts recommendations on MSN Money or some other source and make investment decisions based on them.
Loss of innocence
Not me. My eyes were opened when I went from a newspaper in Philadelphia to Institutional Investor magazine, where my beat was securities analysis. I learned that analysts have myriad pressures to be positive about companies. The companies they cover may be investment-banking clients of the firm. Writing a negative report would be bad for business.
Much of the information analysts give us is spoon fed to them by the company they cover. If things are going well at the company, theyre fairly accurate. But when things go wrong, like they did at Enron, analysts drop the ball when we need them most.
Beyond that, they have a herd mentality and a very narrow, parochial view. Theyre not good at calling turns in their own industry. There is usually one lead analyst who knows a company best, and the rest follow him.
I interviewed one analyst who put out a sell recommendation on a company, and he was ostracized, not just by the company but also by his peers. He lost his job.
When I was at Institutional Investor, I sometimes relied on buy side analysts, those who work for big insurance companies and other institutional investors to advise them on which stocks to buy. The buy-siders are not big stars like the sell-side analysts, but they do have more reason to be objective. Unfortunately, theyre not generally accessible to small investors.
Analysts' role in the bubble
Now lets move to those savvy investors like Cheyenne and MITM in our community, who have observed that analysts seem to be taking their job more seriously lately, making tougher calls on stocks. Fighting for their lives is more like it.
Analysts played no small role in the tech bubble, finding ever more creative ways to raise their earnings estimates for companies like Cisco Systems (CSCO, news, msgs), Corning (GLW, news, msgs) and JDS Uniphase (JDSU, news, msgs) and leading investors, both individual and institutional, into those stocks.
Before they had recovered from that disaster, they followed Enron right down into the ground without ringing the warning bell. And that despite the fact that at a meeting with analysts, one analyst asked then-CEO Jeffrey Skilling for the companys balance sheet and Skilling called him an [expletive deleted]. Ive never heard a CEO talk like that in a public meeting. This might have been a sign that the company was hiding something, but the analysts didnt think to enlighten us.
The report on analyst reports
So now were all on the same page, newbies and jaded investors alike. We all know the flaws in securities analysis. So what should we make of it?- I think analysts target prices for stocks are meaningless. Ignore them.
- The second most useless thing is the buy/hold recommendation.
- Third most useless is the earnings estimate.
- If analysts begin to upgrade a stock, that might be sort of interesting, especially so if you happen to own it.
- They also issue lengthy reports that can be a good source of news and information, but these are tough for us small investors to obtain.
For the most part, I think we should either ignore analysts or assume that they are followers of the trend rather than leaders.
The same thing is true of much of the other information that comes out of Wall Street. Consider the strategists who, like Abby Joseph Cohen at Goldman Sachs, look at the whole market and economy and broad asset classes. These people are a bit ahead of analysts, but theyre still often followers rather than leaders.
Keeping track
On the same day that Cheyenne posted her thread about Ciena, Steven Milunovich, strategist at Merrill Lynch, advised investors to buy technology stocks. Youll probably remember that the market had been rallying all that week. Less than two months earlier, Milunovich told clients in a report that tech stocks should be sold, according to Bloomberg News.
In fact, Merrill's January report suggested that tech stocks such as Microsoft, the publisher of this Web site, might be heading for a fall because they were too expensive relative to profits. Either profits would have to go up substantially -- 94% over two years for Microsoft -- or stock prices would have to come down for the stock to be attractive compared with its historical valuation, the report said.
At the beginning of March, when Milunovich recommended that clients boost their tech holdings, both Microsoft and the Nasdaq 100 Trust (QQQ, news, msgs) were trading at basically the same point when he issued the January advice to sell. The obvious difference between the two calls was that stocks were rallying in March. We would not chase the rally but use any weakness as an entry point, Milunovich wrote. No. They would actually chase the rally.
Shut off the noise
And so it is with the market. Investors fret that there is too much noise. Shut it all off. At a conference I attended recently, a mutual fund manager said that what moves the market is unknowable unknowns, things like the Sept. 11 terrorist attacks.
You shouldnt be counting on any of these Wall Street folks to chart your course. You have to do that yourself by setting up your own strategy. And once youve done it, dont be swayed by some analyst or strategist. That is the lesson we must learn from the tech bubble and the Enron collapse.
At the time of publication, Mary Rowland owned or controlled shares in the following equities mentioned in this column: Cisco, JDS Uniphase, Microsoft, Nasdaq 100 Trust and Corning.
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