Effectiveness of Analysts Calls - Thread
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Rajesh Desai
Feb 6, 2013, 2:17:15 AM2/6/13
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MUMBAI: The stock markets' collective wisdom appears to be superior to that of analysts, said Morgan Stanley India's managing director Ridham Desai in a report to clients, raising a question mark over the effectiveness of analysts' recommendations.
Desai said analysts went wrong most of the time in stock ratings. For instance, though the market hit a bottom in December 2008, analyst ratings (on stocks) did so only in July 2009.
The market formed a strong support in May last year, but analysts have only now begun ratings upgrades. Earnings revisions take place with a lag of three months while the market leads the economy by six months.
Does this mean that investors should not listen to analysts? Desai says that even though the pooled wisdom of analysts appears less useful, the outlier in the analyst community can make very successful calls.
"When the correlation of stocks across the broad market is high, it means that the macro is influencing stocks disproportionately and it is time to listen to analysts because stocks always have idiosyncrasies. When correlations are low (like now), a macro trade is in play making idiosyncratic analysis less effective."
The success of sell-side analysts follows a sine curve—if the call has gone right in the current cycle, it is likely to go wrong in the next.
"The problem for the buyside, collectively speaking, is confirmatory bias, which is that, the sell-side becomes a source of conciliation for their own call. If the buy-side moves away from seeking comfort and focus less on the call, the value of the sell-side analyst soars," it said.
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CA. Rajesh Desai
Desai said analysts went wrong most of the time in stock ratings. For instance, though the market hit a bottom in December 2008, analyst ratings (on stocks) did so only in July 2009.
The market formed a strong support in May last year, but analysts have only now begun ratings upgrades. Earnings revisions take place with a lag of three months while the market leads the economy by six months.
Does this mean that investors should not listen to analysts? Desai says that even though the pooled wisdom of analysts appears less useful, the outlier in the analyst community can make very successful calls.
"When the correlation of stocks across the broad market is high, it means that the macro is influencing stocks disproportionately and it is time to listen to analysts because stocks always have idiosyncrasies. When correlations are low (like now), a macro trade is in play making idiosyncratic analysis less effective."
The success of sell-side analysts follows a sine curve—if the call has gone right in the current cycle, it is likely to go wrong in the next.
"The problem for the buyside, collectively speaking, is confirmatory bias, which is that, the sell-side becomes a source of conciliation for their own call. If the buy-side moves away from seeking comfort and focus less on the call, the value of the sell-side analyst soars," it said.
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CA. Rajesh Desai
Rajesh Desai
Feb 9, 2013, 5:30:41 AM2/9/13
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Apple stock falls: One prominent example of egg on analysts' facesNEW YORK: In September, Apple shares hit a record $705. And to the overwhelming majority of Wall Streetanalysts, that meant one thing: buy.
By November, with Apple stock in the midst of a precipitous decline, they were still bullish. Fifty of 57 analysts rated it a buy or strong buy; only two rated it a sell. Apple shares continued their plunge, and this week were trading at just over $450, down 36 percent from their peak.
How could professional analysts have gotten it so wrong?
It wasn't supposed to be this way. A decade ago, congressional hearings and an investigation by Eliot Spitzer, then the New York attorney general, exposed a maze of conflicts of interest afflicting Wall Street research. There were some notorious examples of analysts who curried favor with investment banking clients and potential clients by producing favorable research, and then were paid huge bonuses out of investment banking fees. Many investors and regulators blamed analysts' overly bullish forecasts for helping to inflate the dot-com bubble that burst in 2000.
After a global settlement of Spitzer's investigation by major investment banks and the Sarbanes-Oxley reform legislation in 2002, investment banking and research operations were segregated. Conflicts had to be disclosed, and research and analyst pay was detached from investment banking revenues, among other measures.
These reforms seem to have worked - but only up to a point. Other conflicts have come to the fore, especially at large brokerage firms and investment banks. And studies have shown that analysts are prone to other influences - like following the herd - that can undermine their judgments. "The reforms didn't necessarily make analysts better at their jobs," said Stuart C. Gilson, a professor of finance at Harvard Business School.
It may be no coincidence that the only analyst who even came close to calling the peak in Apple's stock runs his own firm and is compensated based on the accuracy of his calls. Carlo R. Besenius, founder and chief executive of Creative Global Investments, downgraded Apple to sell on Oct. 3, with shares trading at $685. In December, he lowered his price target to $420, and this week he told me he may drop it even further, to $320.
Besenius founded his firm a decade ago after spending many years in research at Merrill Lynch and Lehman Brothers. "I saw so many conflicts of interest in trading, investment banking and research, so I started a conflict-free company," he said this week from Luxembourg, where he was born and now lives. "Wall Street is full of conflicts. It still is and always will be. It's incompetent at picking stocks."
Since the passage of Sarbanes-Oxley, several studies have documented a decline in the percentage of analysts' buy recommendations, albeit a modest one, while sell recommendations have increased. "Before 2002, analyst recommendations were tilted toward optimistic at an extreme rate," Ohad Kadan, a professor of finance at Washington University in St. Louis, and co-author of one of the studies, told me this week. "That's still true today, but it's not as extreme. It's a little more balanced."
While investment banking conflicts have been addressed, "the most obvious conflict now is that research is funded through the trading desks," Gilson said. "If you're an analyst and one way your report brings in revenue is through increased trading, a buy recommendation will do this more than a sell. For a sell, you have to already own the stock to generate a trade. But anybody can potentially buy a stock. That's one hypothesis about why you still see a disproportionate number of buy recommendations." That may be especially true for heavily traded stocks like Apple, which generate huge commissions for Wall Street.
But no one thinks conflicts alone can explain the analysts' abysmal recent Apple performance. "There's too much unanimity," Bruce Greenwald, a professor of finance and asset management at Columbia Business School and a renowned value investor, told me this week. "That's what's so troubling. When that many analysts are in agreement, they can't all be conflicted."
He and other experts say there are additional documented factors that help explain why Wall Street analysts are so often wrong: they extrapolate from recent performance data; they chase momentum; they want to please their customers; and they show a tendency toward herd behavior. Which is to say, they fall into the same pitfalls that afflict most investors.
"Why aren't they more sophisticated? You'd hope they would be," Kadan said. "But they always fall into the same traps."
Greenwald agreed. "When something goes up, they all put out buy recommendations. Their models extrapolate past performance into the future. They chase momentum. With Apple, they were right at $600, and they were right at $650, which reinforced the trend. So why would they be wrong at $700?"
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CA. Rajesh Desai
By November, with Apple stock in the midst of a precipitous decline, they were still bullish. Fifty of 57 analysts rated it a buy or strong buy; only two rated it a sell. Apple shares continued their plunge, and this week were trading at just over $450, down 36 percent from their peak.
How could professional analysts have gotten it so wrong?
It wasn't supposed to be this way. A decade ago, congressional hearings and an investigation by Eliot Spitzer, then the New York attorney general, exposed a maze of conflicts of interest afflicting Wall Street research. There were some notorious examples of analysts who curried favor with investment banking clients and potential clients by producing favorable research, and then were paid huge bonuses out of investment banking fees. Many investors and regulators blamed analysts' overly bullish forecasts for helping to inflate the dot-com bubble that burst in 2000.
After a global settlement of Spitzer's investigation by major investment banks and the Sarbanes-Oxley reform legislation in 2002, investment banking and research operations were segregated. Conflicts had to be disclosed, and research and analyst pay was detached from investment banking revenues, among other measures.
These reforms seem to have worked - but only up to a point. Other conflicts have come to the fore, especially at large brokerage firms and investment banks. And studies have shown that analysts are prone to other influences - like following the herd - that can undermine their judgments. "The reforms didn't necessarily make analysts better at their jobs," said Stuart C. Gilson, a professor of finance at Harvard Business School.
It may be no coincidence that the only analyst who even came close to calling the peak in Apple's stock runs his own firm and is compensated based on the accuracy of his calls. Carlo R. Besenius, founder and chief executive of Creative Global Investments, downgraded Apple to sell on Oct. 3, with shares trading at $685. In December, he lowered his price target to $420, and this week he told me he may drop it even further, to $320.
Besenius founded his firm a decade ago after spending many years in research at Merrill Lynch and Lehman Brothers. "I saw so many conflicts of interest in trading, investment banking and research, so I started a conflict-free company," he said this week from Luxembourg, where he was born and now lives. "Wall Street is full of conflicts. It still is and always will be. It's incompetent at picking stocks."
Since the passage of Sarbanes-Oxley, several studies have documented a decline in the percentage of analysts' buy recommendations, albeit a modest one, while sell recommendations have increased. "Before 2002, analyst recommendations were tilted toward optimistic at an extreme rate," Ohad Kadan, a professor of finance at Washington University in St. Louis, and co-author of one of the studies, told me this week. "That's still true today, but it's not as extreme. It's a little more balanced."
While investment banking conflicts have been addressed, "the most obvious conflict now is that research is funded through the trading desks," Gilson said. "If you're an analyst and one way your report brings in revenue is through increased trading, a buy recommendation will do this more than a sell. For a sell, you have to already own the stock to generate a trade. But anybody can potentially buy a stock. That's one hypothesis about why you still see a disproportionate number of buy recommendations." That may be especially true for heavily traded stocks like Apple, which generate huge commissions for Wall Street.
But no one thinks conflicts alone can explain the analysts' abysmal recent Apple performance. "There's too much unanimity," Bruce Greenwald, a professor of finance and asset management at Columbia Business School and a renowned value investor, told me this week. "That's what's so troubling. When that many analysts are in agreement, they can't all be conflicted."
He and other experts say there are additional documented factors that help explain why Wall Street analysts are so often wrong: they extrapolate from recent performance data; they chase momentum; they want to please their customers; and they show a tendency toward herd behavior. Which is to say, they fall into the same pitfalls that afflict most investors.
"Why aren't they more sophisticated? You'd hope they would be," Kadan said. "But they always fall into the same traps."
Greenwald agreed. "When something goes up, they all put out buy recommendations. Their models extrapolate past performance into the future. They chase momentum. With Apple, they were right at $600, and they were right at $650, which reinforced the trend. So why would they be wrong at $700?"
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CA. Rajesh Desai
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