Bear Stearns: Where Did the Analysts Go Wrong?

At some point in almost everyone’s life (usually at a young age) they are told to do their own homework. “Cheating is bad,” they tell us. Worse yet, what happens when you copy the wrong answer?

Often times, the same is true for investing. If you wouldn’t just blindly copy your college economics exam from some random dude sitting next to you, then why would you copy stock picks from someone who you don’t know? Too often investors take analysts’ analysis at face value and too often investors get burned by this mistake.

The latest and most prominent example is the failure of Bear Stearns (BSC). As you have probably heard by now, JPMorgan (JPM) is buying Bear Stearns for a mere two dollars a share. This represents over a 98 percent drop in the well known bank’s stock price since the end of February!

Whenever a stock endures this kind of rapid price movement, it’s because market expectations drastically differ from a company’s performance. In this situation Wall Street believed that Bear Stearns was in much better shape than it actually was. Let’s look at the numbers.

According to Yahoo Finance, in the current month two analysts label the large (I guess, not so large anymore) investment bank as a strong buy, four have a rating of buy, while eight more analysts think that Bear Stearns is a hold. No analyst was rating the firm a sell. The numbers were almost identical for last month too, with just one firm rating the firm a sell. MSN Money shows similar numbers.

The question becomes how did the Wall Street analysts get this so wrong? Granted, Bear Stearns CEO Alan Schwartz recently (before Friday’s melee) assured investors that Bear Stearns had ample liquidity. Why did Wall Street take these statements at face value? After all, Wall Street analysts are the closest people to a company besides employees and customers. If anyone should have known what was up, it should have been the analysts.

I believe that there were two main reasons why Wall Street missed the trouble at Bear Stearns: (1) and most importantly, no one knew how to value many of the obscure financial instruments the firm was carrying on the balance sheet and (2) Wall Street analysts were generally overly optimistic with regards to the firm’s prospects, especially given the firm's recent troubles. The combination of these two events has led to disastrous returns for Bear Stearns shareholders.

At the time I’m writing this, Bear Stearn’s stock price is hovering around $3.50 and $4.00, well over the JPMorgan buyout value. One analyst values the once venerable Bear Stearns at over $7.7 billion dollars (The funny thing about the video is that the CNBC reporter later says that without the JPMorgan buyout, Bear Stearns would be worth zero. So I guess I don’t understand how Bear’s $7.7 billion breakup value makes sense). Clearly, many traders believe that Bear is worth more than the two dollar buyout offer and the market expects another firm to make a higher offer. Wall Street again trusts the same analysts who failed to predict Bear Stearns' ultimate fate.

Other investment banks have taken a beating on the news, with Goldman Sachs (GS) down over ten percent while Lehman Brothers (LEH) is down over 30 percent. Speculation is rising that these firms might have a similar fate as Bear Stearns. It will be interesting to see how Wall Street analysts react to the recent events, but you won’t find me listening to their advice without doing some sleuthing of my own. Hopefully this situation teaches us all a valuable lesson: “Wise men learn from their own mistakes; wiser men learn from the mistakes of others.”

Disclosure: Chandler Lutz does not own shares in any company mentioned (and hopes you don’t either).

Comments

[venividivici:]

There is a simple answer. These hopelessly inept analysts and just about everyone else who makes a living selling advice in the world of finance are no different than car salesmen or real estate agents. They just want you to buy buy buy or at the very least not sell. They never see a disaster coming because they don't want to believe it's going to happen. And even if they do, telling people will only make matters worse.
For the last five I have had a very successful career trading shares but I exited the market in August because of what I saw as the complete lack of credibility in the American financial system. One thing I learnt very early in my investing is that you can not rely on the advice of so called experts. They get it wrong far more often than they get it right. The really smart people are not out there peddling advice, they are doing it themselves.

2008 Mar 18 10:18 PM