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You feel like the skater who just ended up in 13th place
despite doing everything correctly. Please remember, investment
analysts, and especially brokerage house analysts, declare
their allegiance to the company they work for. They are not
necessarily independent.
According to First Call, “In 2000, there were 28,000
recommendations by brokerage-house analysts. As of the start
of October 2000, 99.1% of those recommendations on U.S. companies
were either “strong buy”, “buy”, or “hold.”
Just 0.9% of the time, analysts said “sell.” Less
than 1% sell orders? That’s scarier than Roseanne Barr
in a tutu!
Many brokerage houses engage in multiple investment activities.
However, the
primary source of conflict for many investment analysts occurs
when the investment banking department is underwriting stock
or bond issues of a corporate client. Investment banking provides
huge fees to a brokerage house and there is extreme pressure
on the analysts to recommend a client’s stock even when
the underlying fundamentals may not support that recommendation.
In fact, in a report done by Kent Womack of Dartmouth College,
“Stocks that underwriter analysts recommend perform more
poorly than “buy” recommendations by unaffiliated
brokers prior to, at the time of, and subsequent to the recommendation
date. The results suggest a potential conflict of interest
inherent in the different functions that investment bankers
perform.”
The SEC has proposed that relationships like this be disclosed
anytime an analyst issues an opinion or report but to date,
these rules have not been adopted. So what can you do to determine
whether a stock is worth buying or selling?
- Before you invest in a stock, determine the amount to
invest and when you might need that money in the future.
For instance, if this money is for a new sailboat in five
years, determine whether the potential investment is too
risky or too conservative to meet that goal.
- Validate an analyst’s recommendation by determining
what relationship the analyst’s firm has with the underlying
stock. Check the stock’s 10K annual report or the 10Q
quarterly report to determine whether his brokerage house
sponsor is involved in some advisory capacity.
- Compare an analyst’s recommenda tion to other analyst’s.
With 99% buy
recommendations, however, this is obviously not fool proof.
- Read several independent analyst’s recommendations
and compare their remarks on the stock’s future prospects,
market size, cash flow, the growth potential of the underlying
industry, future innovations, and the health of their financial
statements to see if the stock is worth an investment. Note
potential pitfalls of the stock. For example, if the company
has one major client that accounts for 35% of revenue, what
are the chances of losing this client?
If you’re a novice investor, reduce the reliance on
one analyst’s opinion by
diversifying with mutual funds. Mutual fund managers provide
a good second opinion to investment analyst recommendations.
Of course, mutual funds are generally less risky than individual
stocks and often are ideal for portfolios with longer term
horizons.
If you follow the stock market closely, the first four points,
while tough to do, can prevent those groans of resignation
one year later when you say “Why did I invest in that
stock?” They are not foolproof guidelines by any means,
but if you study an underlying stock, you should be able
to react to environmental factors that might affect its
future performance. Above all, try to stay disciplined in
your investment approach and don’t listen to just anyone
with regard to your investments.
So beware of analysts touting stocks with “strong buys”.
They, like figure skating judges, might be preying on your
emotions and padding their wallets. If you ever see an investment
analyst having lunch with a figure skating judge, see if
they’ll buy you dessert.
Remember, the above figure skating diatribe does not reflect
the opinions of MedAmerica Financial Services, its clients,
or Dick Button. Any
objections to this article should be directed to Chris
Renner at
(800) 842-2808.
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