Buy On Expert Opinion?

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Dairy #7 – Buy On An “Expert Opinion?”

Wall Street employs a good number of analysts. They are paid by their firms to evaluate companies and then issue reports on those organizations and tell the investor whether they should “buy”, “hold” or “sell” stocks.

In the last year or so, a great deal of criticism has been directed at analysts because of their “buy” and “sell” recommendations. In the middle of 2002, according to Thompson Financial, “two thirds of all stocks still have buy ratings and only 2.5% are rated sell.

Over the past couple of months, there has been a good deal of criticism about the state of Wall Street research. Analysts didn’t foresee the wreckage of “tech.” They didn’t warn us about Enron, Global Crossing, etc.

One of the main problems centers around the issue of “banking fees.” Investment houses like Merrill Lynch, Goldman Sachs, Salomon Smith Barney and others make tons of money by taking on underwriting and merger and acquisitions assignments. And, there are those who feel that some of these firms toned down the “negative” research and “played up” the positive.

Jack Grubman was the telecom analyst for Solomon Smith Barney “and the ultimate power broker in the industry.” Money magazine (May 2002) stated that “Nobody did more to spur on the telecom craze than analyst Jack Grubman.

When Grubman’s “e-mail updates hit the news wires, they’d be picked up, pronto, on CNBC. And when he spoke, stocks moved.” (Money, May 2002). For his efforts, he earned some $20 million a year. Now investors are paying the price for believing in his giddy vision of vast gains.”

A good number of stories have been written about his continued work with Global Crossing. From September 1998 through June 2001, he issued at least 16 buy recommendations for the stock. Even as the stock started to fall in early 2000, he continued to recommend it. In 2001, he maintained a $70 target price for Global Crossing even after it dropped to $16 a share. In October 2001, when the stock fell to around $1 a share, Grubman finally cut his rating from buy to neutral. In January, 2002, Global Crossing filed for bankruptcy.

Mary Meeker, from Morgan Stanley continued to recommend Priceline, Amazon, Yahoo and other clients that were down 85% or more from their highest price.

In late November, 2001, more than half of the analysts who were tracking Enron still rated it as a “buy” even though Enron filed for bankruptch filed for bankruptcy less than two weeks later.

Fortune magazine (6/10/2002) stated that back in June 2002 “investment analysts couldn’t find a stock they couldn’t tout. Of 26,451 buy, hold, and sell recommendations, only 213 were sell.

Fortune adds that in researchers at the University of California and Stanford reviewed almost 40,000 stock recommendations from 213 brokerage houses. “The most highly rated stocks had a –31% return for the year.” “Meanwhile, the stocks least favorably recommended (the sells) soared an annualized 49%---a differential of 80 percentage points.”

What is the problem as many see it? One is the payment of millions of dollars to analysts to help the firm to land investment banking deals. Fortune magazine (July 9, 2002) states that “the evidence is overwhelming that those huge financial incentives compromise the analysts’ independence—encouraging researchers to trade gushing reviews and buy ratings for lucrative underwriting and M&A (merger and acquisitions) business.”

In the July 2002 issue of Money magazine they state that “there is no excuse for buying a stock solely on a one-word recommendation.