Analyst Call on Baidu: Why Most Calls Are Useless

There are several reasons I typically ignore Wall Street analyst calls. The most compelling is the fact that sell side recommendations over the long term have been shown to underperform the market with above average volatility. Those are lose-lose metrics for investors.

Such poor performance is largely attributable to analysts being backward looking when they make research calls, despite the fact that they are supposed to be analyzing the equity market, which is a forward looking mechanism. Too many times analysts will upgrade stocks after the firms report strong numbers and vice versa, which does nothing to add to investor returns relative to the benchmark index they are trying to beat. Successful investing requires insight into the future, not reaction to the past.

To illustrate this point, consider an upgrade from UBS analyst Wenlin Li on Monday. Li covers Baidu.com (BIDU), the internet search giant in China. Baidu reported second quarter earnings of $1.61 per share, above consensus estimates of $1.44.

Prior to the earnings report Li had a sell rating and $150 price target on Baidu, which was trading over $300 per share. That in itself appears to be a contrarian call, which would be commendable (wrong, but commendable nonetheless). After the strong report was released, despite only a small upside surprise, Li upgraded the stock to neutral and raised the price target to $380 per share, a stunning increase of 153 percent.

How does a single quarter’s earnings beat of 12 percent explain a 153 percent increase in one’s fair value estimate for a stock? It doesn’t, not by a long shot. This is the epitome of a completely useless Wall Street research call.

To see how this analyst messed up so badly, we only need to look at the changes made to their BIDU assumptions. Li now estimates 2009 revenue at $658 million, up from $542 million, while 2010 and 2011 sales are revised upward by 33% and 38%, respectively. Gross profit as a percentage of sales estimates were also revised upward, by 60% this year, next year and 2011, and net profit was revised up by about 40% per year.

Remember, an analyst’s sole job is to follow companies and estimate how much revenue they will bring in and what proportion of that will flow through to the bottom line. Without solid insight into these metrics ahead of time, analyst calls are of little use to investors, which unfortunately is the case more often than not on Wall Street.

Full Disclosure: No position in BIDU at the time of writing, but positions may change at any time

Comments

[azad:]

Analysts are wrong most of the time. Many a times they try to convince with wrong reasons and hidden agenda. Even analyst like Cramer has been so wrong so many times times that I call his show
a "mad show" for madness. Let us be clear. If those analysts know exactly when to buy and sell, they all will be making fortunes without wasting time in writing research(?) articles.

Aug 09 05:30 AM

[buyforeclos...:]

I agree... completely. Analyst I believe get paid large sums under the table to upgrade and downgrade ( shorts) by hedgies and the Likes of GS
I feel many friends of mine were fleeced out of large sums of money by the Criminals on the street who went short to Dow 6500 on exaggerations of huge earnings declines and low balled earnings across the board to joke levels...and then went long at Dow 6500 screaming green shoots!
The thing that angers me is people I know, who had their life savings in stocks, got scared out of the market at Dow 8000- 9000 + - on the way down and sold stocks like BAC for like 5 bucks as it headed to 2's and CAT at like $25 on the way to $22. They were assured by the street this recession would last years and that the stimulus would not be enough, guys like Cramer saying hold onto your money for FIVE YEARS.... yada yada yada ...now they are kicking themselves for selling at such low levels.
I happened to just trade in and out short and long so am doing pretty good but feel for them who were buy and holders.

GS is a criminal company make no mistake and if the SEC pulled their head out of their arses and investigated them , among others, they will find a huge amount o skeltons in their drive in closet.

Aug 09 12:13 PM

[WJM1998:]

Chad hits the proverbial nail on the head with a very good example of a very bad analyst call. And exactly why are those guys paid so much for their hindsight?

Aug 09 12:18 PM

[Jason Chow:]

I agree with Chad completely. The analysts are doing their job, but I always feel hard to believe they are working for the investors.

Aug 09 11:04 PM

[Paul Harper:]

in a lot of cases, I think they are working for their own prop desks.


On Aug 09 11:04 PM Jason Chow wrote:

> I agree with Chad completely. The analysts are doing their job, but
> I always feel hard to believe they are working for the investors.

Aug 17 04:27 PM

[Ames Tiedeman:]

Bidu is soon to be a short. I expect it to go down in September and/or October.

Aug 23 10:49 AM