How to Stimulate the Economy: Fire the Sell-Side Analysts

Having been in this business through the tech bubble and now this mess, you would think that I would've long ago learned to ignore the inanity of sell-side analysts. Talk about complete wastes of space. 99.9% of these "professionals" destroy value in oh so many ways. They collect handsome salaries yet produce nothing of value for the American economy. If you listen to them, you will lose money. Lots of it.

The favorite game now is to spit out a string of descending price targets as a company's earnings decline.

These are invariably after-the-fact calls. When management lowers guidance, or gives no guidance (the analysts' nightmare), the spamalysts extrapolate down and lower their targets. The modus operandi now is to generate targets based on depressed multiples of cyclically depressed earnings. This helps drive stock prices down to ridiculous levels. Of course in October 2007 they were doing the opposite: putting ridiculously high multiples on cyclically peaked earnings. How did that work out for everyone?

Amazingly, some investors still listen to this garbage. Take today's call: "we are reducing our MSFT price target from $23 to $21". Now THERE is some VALUE-ADD, BABY! What good does that shot in the dark do anyone? How about some rigorous analysis of MSFT's true intrinsic value - its value over and across a business cycle? Based on normalized long-term free cash generation tempered with a healthy margin of safety? Way too much to ask.

When these guys do attempt to come up with an intrinsic value, they layer on tons of unimportant minutiae, stack assumptions upon assumptions, and then arrive at an intrinsic value of - wait for it - $100 per share (for AAPL). Wow, that is amazing. All these numbers and formulas and spreadsheets churning away and somehow a nice round, even, easy to look at and understand $100 drops out. I am SURE the guy didn't start with $100 and work backwards... that would be cheating. And disingenuous.

Let's face it: Price targets are investment Twinkies. Taste great, but have no nutritional value and will probably make you sick and fat if you eat too many. They are Wall Street's tool to manipulate the small-minded. Nice, round, easy to understand numbers that most upper primates (and some rodents) are capable of comparing to the current stock price and making an "investment" "decision", hopefully generating commissions for Wall Street.

I don't necessarily blame the analysts themselves, they have no choice. The Wall Street machine dictates their behavior. Of course, they could get another job... okay, I do blame them. All that high-zoot education applied to such a worthless pursuit. Then again, maybe there's a lot more hat than cowboy with most of these folks. I wonder what they do second-best?

So we are supposed to listen to all the negativity being spewed by the smell-side spamalysts. The single-digit multiples of depressed earnings. I mean, none of these guys had it right at the top (or had ever conceived of a single-digit multiple), so I guess that means they must be right now? OR DOES IT?

My prediction: These guys will be so far behind when the bottom does occur that they will be falling all over themselves to double multiples and feverishly raise earnings "forecasts" (after management tells them to). They will miss the first 30-40%, but then their actions will help slingshot the market through the next 30-50% gain. In my opinion, this WILL happen. When? I have no idea. It could be May. 2012. Or 2009. No one knows, especially the analysts.

I propose we pink-slip all these value destroyers and hand their salaries over to folks who are doing innovative things in education or medicine or energy. Now that's what I call stimulus. Are you listening, oh Great Obamulus?

And one more thing. The bottom is in for financials, or it is very close. Not because of the TARP or TALF or BARF, but because famed doom-and-gloom banking analyst Meredith Whitney announced she was starting her own firm last week. Just like when famed bubbly retail analyst Dana Telsey did the same, right near the top for retail.

Comments

[KJP712:]

Qualifications for a sell-side analyst : A comb and the ability to pluck numbers out of the air.Great article.

Feb 25 10:51 AM

[bobbobwhite:]

Analyst bashing has been in vogue for many years now, and way before this latest scandal. You are pretty late to that dance. Any analysts still in the biz now have such thick skins they do not even feel the slings and arrows of any critic, much less the paper cuts you give them here. Why even try to belittle them and degrade them, as they proved themselves to be truly lost souls when they took their specious spin jobs in the first place? And, any with redeeming qualities remaining when hired have been sold out for so long by now that they no longer care that what they do is wrong for investors even if they still have a clue that it may be.

The best way of explaining what has happened to white collar America is to look at the 3rd world's attitude toward good moral and ethical behavior....."I don't care if it is right or wrong.....what do I get out of it". That's just where we are today after this latest rash of white collar and gov't crime....the 3rd world.

Feb 25 11:04 AM

[Nick Waddell:]

Todd,

But how do you really feel about sell side analysts?

I can tell you from first hand experience that the "Chinese Wall" that was supposedly torn down after the dot-com era is alive and well. For instance, we were looking for analyst coverage for a client of ours, Serenic Corp (TSXV:SER) during 2008. Great little company, just no one knew about it. Serenic didn't need a financing, just some recognition. It became clear to us after seeing the 50th investment bank; no financing, no coverage.

The analysts are hamstrung by what the bankers do. If you are thinking about investing in a company because of what an analyst says, check and see if his bank does business with that company. It sounds like the simplest of due diligence measures, but many of us fail to look.

Disclosure: I own SER

Feb 25 11:08 AM

[Jolly_Rancher:]

They will never be fired. But we make them obsolete by taking away the thing that keeps them going: high trading volume and short term sappy investors. And here's how to do that: 1) No margin allowed. 2) No short sale allowed. 3) Set long term capital gains tax to ZERO. 4) Dividends (incl. extraordinary) payable only to long term holders. 5) Net short term capital loss not deductible from taxable income, only long term capital loss. This'll take away all of their candy and will help investors focus on investing in companies instead of gambling on paper.

Feb 25 11:24 AM

[sundrenched:]

Jolly Rancher, I agree. I'd add a short-term capital gains tax as well, like some countries (Germany for instance) have. All these trend followers and day traders add nothing to price discovery, to the contrary. And how much damage has been done to the economy just so some speculators could make some money in oil in the first half of 2008? Yeah, I know it wasn't the only thing by any means, but it did make things a lot worse.

Feb 25 11:39 AM

[akapital:]

I like your proposal at the end there....but how exactly do we do this re-appropriation? Apparently our society values the services of these analysts...and sports stars and actors and actresses over teachers, scientists, etc.

I can think of two scenarios here. The market economy will shift reward to real value or gov't can compensate for what the market economy misses. I think we are at scenario two now. The market economy fudged up...

Feb 25 11:47 AM

[xsellside:]

Sell side bashing is a little passé, isn’t it? I think this misses the mark because what you fail to point out is that institutional investors don’t care much about buy/sell/hold ratings, and care even less about price targets. The value that the sell side brings is information flow - models, access to management, access to industry contacts, conferences, the thesis on the stock/sector, proprietary research like surveys, etc. To be sure, price targets and ratings are stale metrics in an imperfect system. But if you really understood the system, you’d realize that this really isn’t the point.

-Recovering sell side analyst

Feb 25 12:01 PM

[xsellside:]

If there are no sell side analysts AND no buy side analysts, then what we are left with is passive/index investing, yes? But with no analysts researching stocks, stock prices won't find equilibrium and indexing won't work. Oh no! It’s a paradox!!


On Feb 25 12:11 PM ED K wrote:

> Any knowledgable investor that does the amount of research necessary
> to form an opinion of a company knows immediately after reading an
> analyst report whether he is being objective or pushing a stock his
> employer owns.
>
> The analyst inability to be objective have caused the loss of confidence
> they now experience.There is no room for either sell or buy side
> analyst in todays markets.
>
>
>

Feb 25 12:23 PM

[H.J. Huneycutt:]

Amen, brotha!

I don't know why anyone even bothers with the analysts. They never adjust their outlook till after the fact. They are more of a contrarian indicator than anything. But you said it all already. Great article!

Feb 25 12:39 PM

[H.J. Huneycutt:]

I'm in full agreement on this. I'd like to see a new short-term capital gains tax (for stocks owned under 3 months) set at a rather high rate --- say 50%. Maybe even put in an under-two-week cap gain tax at 85% to prevent extreme short-term speculation. We can offset that by lowering the dividend rate to 10% and creating a new long-term cap gain classification (more than 3 years) and setting it at 10%.

In general, the system needs to be reformed to promote *ownership* of companies and discourage speculation.


On Feb 25 11:39 AM sundrenched wrote:

> Jolly Rancher, I agree. I'd add a short-term capital gains tax as
> well, like some countries (Germany for instance) have. All these
> trend followers and day traders add nothing to price discovery, to
> the contrary. And how much damage has been done to the economy just
> so some speculators could make some money in oil in the first half
> of 2008? Yeah, I know it wasn't the only thing by any means, but
> it did make things a lot worse.

Feb 25 12:44 PM

[xsellside:]

I think it was Warren Buffett that said the short term capital gains tax should be 100%.

Feb 25 01:46 PM

[Bill Jencks:]

Quite a rant. But, lets face it - the market forecasts and warnings of Warren Buffet, Jim Rogers and Marc Faber are worth a listen. These are all people who see great market as well as economic problems for the US in the future. I tend to believe these gurus, since they have no reason to be Wall Street analyst clones.

And, of course, George Soros - at a recent dinner speech this week at the University of Columbia - said that this 'recession' would be as bad if not worse than The Great Depression.

George Soros also said that the bottom was nowhere in sight yet.

Feb 26 10:12 AM

[kelm:]

I see nothing in anything you say in the article that does not apply equally well to the buy side analysts. Remember, the ones who helped inflate the internet bubble - Blodget, Meeker etc...

And oh look...Your profile says you are a long only manager

Very few Wall Street analysts or indeed anyone in the financial industry actually does detailed analysis to a sufficient rigor to offer a real opinion worth following. A bull market allows one to have shoddy buy side analysis which is covered up by the broader market's advance and the reverse happens during a bear market.

Anyone with a buy side bias right now is frustrated beyond belief that a good company that may truly have long term value gets caught up in an avalanche of bear reviews by know-nothings. The same is true during a bull market though.

Look for the fundamental global trends, formulate a strategy, find the trades which execute the strategy and ride the wave.

Feb 26 12:26 PM

[Eric Welch:]

Right now it is a good time to be a sell-side analyst. Its not a worthless pursuit because otherwise there would be no market, and everything would just appreciate, and at what point would it be overvalued? This is exactly what got us into this crisis in the first place. The housing prices were just expected to go up and up and up... except for one person, Kyle Bass. The hedge fund out of Dallas was not buying the assumption that the housing market will never crash. This "irrational exuberance" should not be encouraged by firing sell-side analysts. Is Kyle Bass, or his team, to blame for this crisis? Absolutely not, if not Mr. Bass then who, there would have been losers and winners (meaning lost the least) either way. Kyle Bass came down on the right side of the trade, and that is what his job is. Not to destroy the American economy, but to provide truth. The truth is that there is no truth. There are only opinions that in the marketplace are allowed to duke it out. Mr. Bass and his team made a decision not to get swept up into group think, and stay honest and smart. What if Apple is really worth $100? Investors are worried about the health of Steve Jobs. Is this not reflected in a lower stock price? Projections are number projections, and numbers lie. We can make the numbers say whatever we want to, but the difference of opinion gets settled in the marketplace.

Feb 26 06:41 PM