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Analyzing Analysts' Language

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How to parse the obfuscating language of people whose picks are often on a par with a dart board.

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MINYANVILLE ORIGINAL

Editor's note: This take on the often unintentionally hilarious language analysts use is a companion piece to The Rise of the Ax-Wielding, Market Moving Analyst, which is a thoughtful review of both the role and impact of stock analysts on financial markets.

A Buy by Any Other Name

The dizzying array of descriptions analysts assign to their opinions, from Long Term Buy to Short Term Sell, are enough to give anyone whiplash.

For favored stocks, beyond the basic "Buy" lie endless variations of Strong Buy, Speculative Buy, Action Buy, Accumulate, Outperform, and Overweight. (The latter recently had unintentionally comic consequences when it was assigned to, of all things, weight loss stocks.) Apologies to any other iterations of "Buy" I've inadvertently left off the list. All of these can be repackaged and found on things like the Fresh Money Ideas List, Top Picks Live List, Conviction Buy List, and Focus List.

"Hold" -- often perceived by savvy investors as a four-letter code for "Sell," which in turn means "head for the hills" -- has a similar slew of sidekicks. Among them: In Line, Neutral, Market Perform, Perform, Sector Perform, Equal Weight, Market Weight, and Average. (Not to be confused with Above Average, which inhabits the strange netherworld between Buy and Hold.)

To soften the blow of saying the unpleasant and still exceedingly rare "Sell" (which even now, represents only about 5% of all recommendations) there are several softer-sounding synonyms, including Underperform, Reduce, Avoid, and Underweight.

Many institutional investors, if not yet the general public, learn to filter out the overall rating, instead opting to focus on tidbits contained within the accompanying report or a subtle change in an analyst's tone.

Meantime if you don't care for a current research recommendation, just wait awhile. One top firm famously had three separate ratings on a key Dow component in the course of a single day.

Moving Targets

Price targets are an analyst's best prediction as to where a stock price will trade within a specific time frame, typically 12 months or more rarely six months. They are sometimes right, often wrong, and certainly shouldn't be seen as infallible for the simple reason that no one can accurately predict the future.

The more eye-catching forecasts can make headlines and occasionally careers. In December 1998, Henry Blodget of Oppenheimer put a pie-in-the-sky $400 one-year objective on Amazon (AMZN), then trading at $242 3/4. A self-fulfilling prophecy saw shares subsequently surge $46 in the next 24 hours, and blow past $400 in about three weeks. Mr. Blodget's new found fame propelled him to a high-paying position at Merrill Lynch in a matter of months.

An analyst who assigned a similarly outlandish $1,000 target on Qualcomm (QCOM) exactly a year later fared less well. The tech stock, having split 2-for-1 in 2004, was last seen trading at around $56.

In early 2011, a researcher at Topeka Capital was the first to assign a four-figure target on Apple, placing a $1,001 projection that was raised to $1,111 in April. Such cute specificity may make for a useful marketing tool and can help to stand out from the crowd, but is also indicative of what ex-analyst Andy Kessler has called "target creep, an ever-upward bias on numbers so calls could be made."

Buyer Beware

Beyond an aversion to saying "Sell," arguably the most common complaint about equity analysts is that they are lavishly paid for reacting to, rather than anticipating, events. To take examples from just this June, Tempur-Pedic (TPX) received a rear-view downgrade one day after tumbling 48.73%, as did Nokia (NOK) 24 hours after a fall of 15.77% that took it to a fresh 16-year low.

The reverse also holds true, with International Game Technology (IGT) upgraded -- albeit to no better than Neutral -- by one big brokerage firm mid-month on the morning after it surged 14.37% to pace all S&P 500 (^GSPC) advancers. Investors could reasonably argue they would have been better served had these judgments been made long before the horse bolted.

Another investor peeve is a lockstep "march of the penguins" mentality and herd instinct to which analysts are often prone, with calls clustering around a consensus for fear of appearing foolish. For instance, at last count Apple had fully 45 "Buy" recommendations and only a single "Sell." (Interestingly enough, this "Sell" was from Walter Piecyk, the same analyst who 13 years earlier slapped the sky high price target on Qualcomm.)

The sheer number of analysts following the Cupertino tech darling hints at another issue, namely saturation coverage that often brings adverse effects of its own. According to Bespoke Investment Group, the average S&P 500 company is covered by 22.3 analysts but when that number soars to stratospheric levels, the potential for upside surprises tends to evaporate, and performance can suffer.

In 2011, for instance, Research In Motion (RIMM) had no fewer than 54 analysts assigned to it; shares have since fallen by over 60%. As it is, many outsiders feel the game of "earnings surprises" is rigged, with S&P companies having now beaten analysts' estimates for 13 straight quarters and counting. (To be fair, fewer companies are issuing official earnings guidance than ever before, which makes accurate forecasting increasingly hazardous.)

Mixed messages are another common complaint, as when an analyst cuts their price objective, often substantially, but maintains a bullish overall recommendation.

And for all the lip service paid over the past decade to industry attempts at building better Chinese Walls, Wall Street research remains susceptible to conflict of interest accusations. Earlier this year, four of the five banks that took Zynga (ZNGA) public coincidentally began covering the company with table-pounding "Buys." Last week, its shares slid 16.58% to fresh lows.

Rating the Raters

For decades, the industry's Oscars were Institutional Investor's All-America research awards, established in 1972 and unveiled to much fanfare each October. Last fall, the magazine polled 3,500 money managers who collectively controlled $10.7 trillion in US equities. The survey of all-star analysts remains extremely influential, and a top ranked researcher can see his or her salary soar accordingly.

However, criticism that the rankings represent little more than a subjective "beauty contest," based on industry politics and popularity, led the Wall Street Journal to introduce its own "Best on the Street" study in 1993. For its part, the newspaper purports to be a more empirical guide to actual stock picking prowess, and in tandem with FactSet Research Systems (FDS), evaluates over 2,000 analysts from almost 200 firms.

Extel and Greenwich Associates are other organizations that analyze the analysts. Interestingly, while individual investors tend to focus on analyst's bottom line of "Buy," "Sell," or "Hold," large institutions invariably say they place far more importance on industry knowledge, idea generation, and accessibility.

Conclusion

Shameless cheerleaders designed to bring in banking deals, whose picks are on a par with a dart board, or objective and impartial third parties serving the greater good? The truth, as ever, lies in between.

Admittedly, analysts are often overly cozy with company management, their very role inherently riddled with conflicts of interest. The profession's wild-eyed optimism on stocks under coverage should be considered with a healthy degree of skepticism.

That said, the best of breed perform an invaluable service by parsing critical intelligence, unearthing nuggets of information, putting insights into a wider context, and giving investors actionable advice. They must try to placate competing constituencies while under pressure from all sides, and work under an ever more enveloping array of red tape.

At some level, investors -- rather than seeing themselves as passive victims of botched "Buy" recommendations -- must also accept that ultimately no one is forcing them to slavishly follow advice of self-styled "experts." For every high profile bad apple analyst, armies of others toil away in anonymity, mining spreadsheets for invaluable data deep into the night.

Interestingly, it turns out that a surprising number of research big wigs, past and present, have a history background. Mr. Blodget studied the subject at Yale, Meredith Whitney at Brown, and current Bank of America-Merrill Lynch Global Research Chief Candace Browning at Brandeis.

When history repeats, or rhymes as it often does, or the next bubble bursts, blame overly rosy analysts if you must. But they shouldn't shoulder all of the responsibility.
No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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