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

by: Todd Kenyon, CFA

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.