Why I Hate Analysts

Excerpted from
The Faber Report; How Wall Street Really Works :And How You Can Make It Work For You
By David Faber, Ken Kurson

In April of 2001, when Enron's stock was riding high and life was good, the company's newly minted CEO Jeffrey Skilling held a conference call with analysts to discuss recent financial results. It was a pleasant affair. Many analysts prefaced their questions with heartwarming congratulations on a "great quarter" and a "fabulous job." The questions were similarly polite and unfailingly shallow.

Then a more hostile tone was heard on the call. A questioner who didn't take as a given that Enron was fabulous or great asked Skilling why Enron's balance sheet was inevitably so late in being filed with the SEC. Skilling, who if he'd been born a hundred years earlier would surely have been a steely-eyed gunslinger in the same state his company hailed from, showed a surprising loss of composure. He called the questioner an asshole. And who was this "asshole" analyst? Not an analyst at all. It was a hedge fund manager who had been questioning the inner workings of Enron's business for some time.

The analysts on the call heard the exchange. But did any of them think to follow up on the "asshole's" line of questioning? Apparently not. Almost every analyst who followed Enron in April 2001, eight months before the company would file for the biggest bankruptcy in corporate history, thought the stock was a "buy."

The aim of a stock analyst is the same as it has been since modern securities analysis came into existence roughly twenty-five years ago: know everything there is to know about the companies within a particular industry sector and about conditions that affect the sector itself. The automotive analyst's job is to determine how well GM's cars are selling and how much profit GM is making on each car. That requires a detailed knowledge of things like the cost of raw materials, labor conditions, currency exchange rates, and all the other things that can have an impact on the profitability of a company that makes cars. Ideally, the analyst gleans this information just as a reporter would. He visits the manufacturers, interviews suppliers and customers, and pores over the company's accounting statements and other sources with keen instincts, a bunch of experience, and a finely tuned car for bullshit.

The analyst then writes a report explaining what's up with the company and/or its sector, detailing why he thinks the stock will rise, coast, or, in those rarest of imagined circumstances, actually go down. He writes a report that also includes a short- and long-term rating of the stock and a target price. Each firm has its own convoluted rating system, in which a simple "buy" or "sell" has no place. My favorite is that employed by analysts at Goldman Sachs. At one point, the firm had the following ratings: "global priority list," "priority list," "recommended list," "trading buy," "market perform," and "market underperform." As you can see, five of the six ratings implied that the stock would do at least as well as the market. Not every firm is quite that ridiculous, but ratings generally break down in similar fashion.

The analyst's research report is communicated to clients by the firm's sales force and by the analyst on the firm's company-wide speakerphone (known as a squawk box). Analysts communicate upgrades and downgrades to their firm's sales force on the "morning call," which typically begins at about 7:00 A.M. or so. The sales force then transmits that information to the firm's big institutional clients while the analysts get on the phone with selected clients. The retail guys - the friendly stockbroker you opened your account with - have no hope of speaking directly with the analyst (unless they are one of the firm's huge producers), and in turn there's about no chance they'd take the time to speak with you.

Earnings estimates are the most widely followed part of an analyst's work. The numbers are reported to First Call and/or Zacks, companies that compile the estimates of many analysts to produce the "consensus earnings estimate" that so many of us rely on as the barometer of quarterly success. But an analyst report is a reliable source for any number of baseball-card-like stats - the company's revenue growth rate, the size of the market, the company's market share, stuff like that. The reports give many investors the numbers and the models that can help them compare one company with another in a variety of ways, and they provide the all-important estimates of profit a company is expected to earn in the year ahead. When news on the sector or company surfaces, analysts gets on the squawk box and try to explain the meaning and effect of that news on the companies they follow.

In any given week, the stock analysts of Wall Street issue hundreds of reports on the companies they follow, either to update shareholders on news that affects those companies or to offer a new opinion on a company. On many-occasions the stocks mentioned react to those "research calls" by moving up or down, depending on whether the opinion stated is positive or negative. Often the stocks move because of the news, not because of the analysts' commentary on that news. Still, not a day goes by that some company's stock price is not noticeably affected purely by the opinion of an analyst. On January 2, 2002, for example, a ratings upgrade of EMC by Salomon Smith Barney was responsible for sending the stock higher by 12 percent on the day.

The Best Call

Plenty of fund managers are in constant contact with analysts, looking for insights, info, and gossip. In these conversations, analysts speak freely about the stuff they know but can never share publicly. It might be what they heard from a CEO who asked them for an opinion on takeover candidates. It might be a negative take on the management of a company they just met with.