By Lance Ignon (Investors’ Business Daily, 1998)
Today’s equity analysts are better educated (CFAs, MBAs, CPAs) better informed and command more computer muscle than ever. What they lack, critics say, is courage.
Instead of leading clients to investment ideas, many analysts follow the crowed, churning out duplicative research reports that become part of a cacophony of timid group-speak.
“Too many analysts think alike; too few are willing to risk being wrong by taking a gusty, controversial stand,” according to a widely circulated report last month from market strategist Byron Wien at Morgan Stanley & Co.
Wien’s sentiments were echoed in interviews with other market strategists, mutual fund managers, research directors and analysts themselves.
Such complaints are not new, but they come at a time when research departments are slowly rebuilding their ranks following layoffs several years ago. These new analysts will be of little use, however, if they fall in with the herd and fail to produce ground-breaking research.
Critics say both analysts themselves and the incentives that drive the brokerage business are to blame for the group-think.
In a job where performance is measured every trading day by eights of a point, many analysts find security in mimicking their peers. If they are wrong, at least they don’t stand out. Yet, analysts’ opinions are most valuable when they are not only correct but also are in the minority.
If you’re always with the consensus, you probably won’t make much money, but you won’t get fired,” Wien said in an interview with Investor’s business Daily.
Stefan D. Abrams, managing director at Trust Co. of the West, argues that brokerage firms put too much emphasis on the morning call, when analysts announce their latest recommendations to their firm‘s brokers.
The practice may generate lots of trading commissions, but it also leads to a confusing fragmentation of information.
“Analysts are basically not doing the job of helping investors develop conviction in the long-term prospects for companies.” Abrams said.
“They’re too preoccupied with the morning call so they can spout some information that may not be that important. It’s a tidbit of information. Analysts are in the tidbit business.”
The very nature of the brokerage business also stunts the effectiveness of research.
CLIENTS’ INTEREST
An analysts’ purpose, after all, is to come up with winning investment ideas that will prompt their institutional clients to trade stocks through their firm’s brokers and generate commissions. But many of these clients are interested only in larger, more liquid stocks, so analysts tend to concentrate on these types of companies.
Often, “an analysts picks up a stock simply to attract trading calls, “ said Jonathan C. Schooler, a mutual fund manager for AIM Advisors Inc. in Houston.
The result is that dozens of analysts end up covering the same behemoth company. For example American Telephone and Telegraph Co. and NationsBank, the most widely covered U.S. companies , are followed by 59 analysts each. According to Nelson Publications Inc.
The 25 most widely watched U.S. companies have an average 52 analysts each.
By virtue of their size and number of shareholders, these companies deserve wide coverage. But each additional research report adds less value if, as is often the case, it resembles the reports it succeeded.
Moreover, this kind of duplicative effort leaves analysts less time to ferret out tomorrow’s AT&T or Microsoft Corp.
Of course, there are analysts who make a point of discovering companies early in their growth cycles and who are not afraid to cut their own path.
Oppenheimer & Co.’s Cecelia Brancato started following Cisco Systems Inc. in the summer of 1990. It has since increased 2,344%.
OTHER SIDE OF THE STREET
Brancato said she knew about Cisco even before its market debut, and recognized the potential for both the company and the entire computer networking industry. This gave her the conviction to ignore the periodic negative rumours that would temporarily weaken the stock.
“Typically, I am on the other side of the Street, whether it be on my opinion or my earnings estimates,” she said. “More often than not.”
ORIGINAL RESEARCH
Wien and others suggest, however, that analysts would build more credibility by conducting original research and developing maverick opinions that help clients make money.
Meantime, many institutional investors will continue to do their own research, they say, because too much of the information from Wall Street is stale.
“I throw those things out,” Art Bonnel (PM of MIM Stock Appreciation Fund) said, referring to most research reports. By the time it gets to me, everyone knows about it.”
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Coal in a battle of “survival of the fittest,” Citigroup says
- A day after Credit Suisse warned that coal miners such as Arch Coal (NYSE:ACI) and Alpha Natural Resources (NYSE:ANR) were in “dire straits,” Citigroup analysts say it will be “survival of the fittest” for the world’s coal miners.
- While Citi believes current coal prices are below sustainable long-run levels, it does not expect a return to prices anywhere near the levels seen a few years ago; the firm cuts its long-run thermal coal price forecast to $80/ton from $90 and its met coal price forecast to $125/ton from $170.
- The firm sees China and India as the largest sources of downside risk to its long-run forecasts, particularly for met coal, where China could re-emerge as a net exporter.
The above “research” copy-cats an amazing insight of the obvious as coal company, ACI, declines from $78 to 49 cents:
Ask yourself what was the purpose of stating the obvious after the fact? The analyst should produce original work such as what has the market already discounted today? What about an industry-map showing production costs and sales per ton for each type of coal and where mines are located relative to domestic and export markets? What are the dynamics effecting the market and what can change? How much supply needs to be reduced? Who will and won’t benefit from consolidation? Do the companies have different management than the CEO’s and Boards of Directors who took on debt to make acquisitions at the top of the market in 2011? What drove management’s actions. Can companies work together to merge and rationalize supply and return to profitability.
Reporting the obvious to mimic a competitor seems silly. What do YOU think?
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A reader suggests a sub-group (off of the Deep-Value group at Google Groups) be formed to learn and study different concepts. I certainly encourage the idea. Let me know how I can help.
