Decoding Wall Street's Well-Kept Secrets
- What Is a Wall Street Securities Analyst?
- Wall Street Analysts Are Bad at Stock Picking
- Opinion Rating Systems Are Misleading
- Research Never Contains an Analyst's Complete Viewpoint
- Wall Street Has a Congenitally Favorable Bias
- Downgrades Are Anguishing, Arduous, and Rare
- Most Downgrades Are Late; the Stock Price Has Already Fallen
- Buy and Sell Opinions Are Usually Overstated
- Wall Street Has a Big Company Bias
- Brokerage Emphasis Lists Are Not Credible
- Stock Price Targets Are Specious
- The Street Orientation Is Extremely Short-Term
- Analysts Miss Titanic Secular Shifts
- Street Research Is Unoriginal; Opinions Conform
- Analyst Research Is Valuable for Background Understanding
- A Lone Wolf Analyst with a Unique Opinion Is Enlightening
- The Best Research Is Done by Individuals or Small Teams
- Overconfident Analysts Exhibiting Too Much Flair Are All Show
As a securities analyst for 32 years, I am amazed that naive investors can be so misled by Wall Street doubletalk. You can be an astute investor only if you fathom the puzzling and often deceptive nature of the Street. Wall Street operates in strange, ambiguous ways that it would prefer to keep secret. Do what Wall Street does, not what it says. Do not take the Street literally. Its research cannot be trusted. Corporate executives react to Street sentiment, attempt to influence their own stock prices, and also deter objective investing. The individual investor is an afterthought, mostly neglected by analysts and broker-dealer research departments. The Street cannot be ignored. But if you understand the research game to the same degree that professional portfolio managers do, the playing field will be more even. By unscrambling Wall Street doubletalk and decoding the confusing, cryptic Street practices, you can unlock the handcuffs that inhibit superior investing, to protect and build your portfolio.
Wall Street brokerage firms focus first and foremost on themselves, and after that on institutional clients such as mutual funds and hedge funds. One of the most important profit centers is the trading desk, transacting myriad trades each day as a principal (generating profits for the house account). In his Forbes column, Laszlo Birinyi, Jr., who heads a financial/investment consulting firm, expresses the concern that the Street “serves itself rather than its clients...at the expense of individuals and mutual funds.” He states that “an awful lot of short-term trading profit [is] swallowing up money that in the past would have ended up with long-term investors.” The only way for the individual investor to offset this disadvantage is to hold stocks long-term and be aware of the Wall Street system to the same degree as the insiders.
In mid-1985, I decided to take a new job with Merrill Lynch, but first I had to sit tight for ten days. I was scheduled as Louis Rukeyser’s guest under the Salomon Brothers moniker and could not resign gracefully until off the set of Wall Street Week. I was already feeling edgy when I arrived in the remote horse country of Owings Mills, Maryland. After I’d cooled my heels a couple hours in the studio, Lou, who had not finished writing his commentary, was still not ready to tape the show at the normal time that Friday evening, an hour before it aired on PBS. So my appearance was one of his infrequent programs that went on live—adding pressure and more time to stew. Seated just off the set for the first half of the program with a pitcher of water, I was told to be still or the viewers might see the movement of my shadow. Nervously, I consumed most of the jug and badly needed relief about the time the hostess grabbed my arm to strut me out to the couch in front of the cameras and panelists. My bladder bulged as we wheeled into camera view and the hostess whispered to me, “Do not trip on the platform—three million viewers are watching.”
Analysts like me are not accustomed to being grilled. We normally have the upper hand. At least we are good at faking aplomb and we rarely come unraveled. I sank down into the gigantic soft sofa, feeling like a midget looking up at Rukeyser, who towered over me in his high-perched chair. All my hours of practiced answers flew out of my head. I was babbling. It was like truth serum, but I survived. This book puts you in Rukeyser’s shoes. It unravels Wall Street security analysts and their research. And it will give you investment strategies to counter the Wall Street bull.
What Is a Wall Street Securities Analyst?
To comprehend Street research, you must first be familiar with the function of a securities analyst. I am talking about an analyst at a brokerage firm investment bank, not an in-house stock analyst at mutual funds, banks, or investment management firms that cater only to the portfolio managers within his or her own firm. The job function of brokerage analysts is to conduct research on companies and industries and “sell” it to the brokerage institutional clients and secondarily to individual investors. A typical Street analyst heads a small team of associates, is situated in New York (I was in New York for 20 years and then relocated to San Francisco for the last 12 years of my career), has maybe a dozen years experience, and is in the 30-to-40 age range. The ideal analyst has an MBA degree, should be a Chartered Financial Analyst (CFA), and is adept at reading and interpreting financial statements, understanding and building complicated mathematical earnings models on a computer, writing research reports, talking and interviewing, and selling/marketing. This is a wish list, because rarely do analysts have all these qualifications.
The primary requisite of any analyst is to be an expert on a particular industry sector and group of companies therein. There are analysts covering areas such as high-tech semiconductors or software, retail specialty stores, the oil and gas industry, biotech, airlines, utilities, and banks. I began covering the entire computer industry in the 1970s when it was small, gravitated toward focusing on software and computer services in the 1980s, and then covered only computer services starting in the 1990s (companies such as EDS, Automatic Data Processing, and Accenture). Analysts conduct research on and rigorously track a limited number of companies in their chosen industry area. They must understand the dynamics, influences, and underpinnings of the industry, and be exceptionally familiar with as much detail on each company as possible—elements such as the financials, products, competitive position, management, strategies, and research and development. Analysts must be able to judge executives; assess the impact or effect of any number of influences, such as competitor pricing or a demand falloff on a company; have the vision to see the big picture amid tumultuous current pressures on a stock; and analyze a company’s outlook with incomplete information in an unclear situation.
It is common for analysts to have worked in the industry they are covering before starting on Wall Street. Analyst industry expertise is more important than a background in securities, investment, or finance. I became savvy about the computer industry while employed at the U.S. Department of Commerce tracking the sector there. Wall Street recognized my knowledge of the area and hired me for that reason, not because of my MBA degree.
The second-most-important analyst qualification is an understanding of the stock market, investment, and securities (stocks, bonds, options, convertibles, and so on). This is basic stuff, things such as listed versus NASDAQ-traded securities, bid and ask spreads, stock buybacks, dividends, share issuances, stock options, debt (bonds), and all the mechanical aspects of the stock market. Sometimes this knowledge is obtained while earning an MBA degree, or on the job, in the business, as a junior start-up analyst; and it is enhanced in the process of acquiring the professional CFA designation. I did both but was further ahead of the game due to my college summer job at a small brokerage firm in Chicago, when I first began reading financial newspapers/magazines and books, investing on my own, and following the market for years before I landed on Wall Street.
Street analysts also need to have some grasp on the economy. My undergraduate degree was in economics. Several economic factors impact stocks and company fundamentals. Analysts should be conversant with elements such as interest rates, employment, GDP, inflation, recessions, government spending and borrowing, foreign currencies, and international trade. An MBA degree is a key source to absorb background in economic disciplines.
The securities analyst’s role is to determine the industry and individual company outlook in the sector covered, conclude whether the stocks are attractive investments (a Buy opinion) or likely to perform poorly (a Sell), write up these findings in research reports, and monitor all this on a continuing basis. A key mission is to then verbally communicate this research to the brokerage firm’s institutional investor clients and other key audiences, such as the in-house sales force and traders on the desk and the outside media. Notice I left out retail individual investors. Analysts do not deal with them directly. Analysts on Wall Street must sell their research, that is, market their product and views. To be proficient at this so-called marketing, analysts must be outgoing. No shy types. They make presentations to single portfolio managers or a room full of institutional investors. Analysts need to be convincing on the telephone and over their firm’s squawk box. They must have conviction; be strong, opinionated, and confident; and come across as cool, intelligent, and balanced, similar to a 747 airline pilot during a turbulent thunderstorm (my worst nightmare). This requires personality, charm, and a colorful and engaging character. (Of course, I was all that and more—did I mention humility?)
The brokerage institutional salespeople cater directly to the portfolio managers, traders, and analysts at the firm’s institutional clients—mutual funds, hedge funds, pension funds, banks, and other financial institutions. All day long, they carry the analyst’s research message to these institutions, in person, on the phone, or by e-mail. Salespeople might cover a half dozen such institutions and talk with perhaps five or ten key contacts at each one. They also help sell to these big clients initial public offerings (IPOs) and secondary share issuances their firms are underwriting, and set up meetings between their analysts or corporate executives and these institutional customers. Traders execute sizable buy and sell orders on behalf of major clients and attempt to make money for the brokerage firm’s own account by trading stocks. Investment bankers deal with corporations, governments, and other entities in need of such financial services as selling stocks or bonds, doing mergers and acquisitions, and structuring complicated financial/investment transactions.
What is a typical day in the life of an analyst? During the latter portion of my career, I was located in San Francisco, where the stock market opens at 6:30 a.m., so my hours were on the early side. My firm’s morning conference call, where research analysts present pertinent new views or updates, commenced at 4:15 a.m. I rolled out of bed at 4:10 a.m., tossed on my sweats, and jumped on the horn. Because this live broadcast went out to hundreds of offices worldwide, it was critical to not fall asleep or screw up. Then, after donning slacks and a sweater, I drove through dark streets, grabbed a giant coffee, cream, and sugar, and was at my desk by 6 a.m. Things were now happening full blast because it was 9 a.m. in New York. The sales force was on my case to call key institutional clients to add color to the comments I made on the earlier morning call. My stock screen was racing with price changes, news stories, and other information. E-mails by the dozens pleaded for responses, opinions, scheduling, and all sorts of other matters. My team was just outside my office door, wanting to chat or discuss research. No help from my administrative assistant, who waltzed in at about 7:30 a.m., and worked fairly normal hours. At some point, I hustled a couple blocks over to a local hotel for a breakfast meeting with a mutual fund portfolio manager.
Back in the office around 9 a.m. The Wall Street Journal called. An executive from a company I covered was in town and showed up at my door mid-morning. We discussed his firm’s business outlook for an hour. My 16-ounce takeout coffee got cold, but I was still sipping it. I had to scrutinize, in advance, a detailed computer earnings model of a company that was to report its results at 1 p.m. this particular day, after the market closed. Soup at my desk for lunch, the first thing I had eaten all day. The earnings results hit the tape. We did instant analysis, prepared questions, and tuned in to the company’s 2 p.m. investor conference call. It was over at 3 p.m., and after a few minutes of pondering and quick analysis, I ground out a research report. Maybe about 5:30 p.m. I waved goodbye to the garage attendants, who gave me no credit since I did not top a 12-hour day. Alongside me on the front car seat was a portfolio of material to review during the evening with a bowl of ice cream and the baseball game quietly on TV in the background.
Abnormal events in the day of an analyst are normal. I was summoned to a pay phone while atop the High Sierras in Yosemite by Ross Perot (the other campers were impressed) and was detained by passport control officers at an Italian border the night Aldo Moro was assassinated. I have broadcast my research comments over the squawk box system from aircraft carriers and jumped on the box from phone booths in Vienna cafes. Sometimes I had the opportunity to take advantage of the firm’s Chicago Cubs Wrigley Field courtesy suite up behind home plate, squeezing in an occasional night game where I had misspent the bulk of my youth in the bleachers. I have witnessed Michael Jordan in the NBA playoffs, gate-crashed the Cannes Film Festival, bumped into Queen Elizabeth exiting a London theater, sipped cocktails at Raffles bar in Singapore, and basked on Waikiki Beach. But there are dodgy scenarios, too. The Kansas City car service driver that I had used for years on client visits there turned up as a fugitive when the police found multiple homicide victims in his home. This mild-mannered chauffeur was on the phone with our Chicago sales desk apologizing that he was not available for the next assignment, while law enforcement was in pursuit. He was later apprehended, convicted, and given five life sentences.
And then there was September 11th. Jenny Dugan, a junior analyst on my team, and I were in New York to conduct a day of one-on-one meetings with investors. Two clients had requested the 8 a.m. lower-Manhattan-area time slot, Fred Alger Management and another bigger mutual fund, which ended up getting the nod. Jenny was meeting with the latter client in the World Trade Center tower at 8:50 a.m., while I was uptown. The first plane hit one floor below the Fred Alger offices where our meeting would have been were it not for that other request. Tragically, no one at that firm survived. She and her group found the stairwell overcrowded and exited via the elevator. To this day she is reticent to discuss her experience that morning. She has hidden away her WTC-2 security building pass issued that morning revealing her photograph and the September 11th date.
The greatest reward a securities analyst can obtain is to be brilliantly correct on a major investment recommendation. I discovered Fiserv as an emerging stock early in the late 1980s, constantly pounded the table with a resounding Buy, and watched it rise steadily in price for more than a decade. A more established company, Computer Sciences, had been a lackluster performer for years when its prospects gradually started to improve. I was the earliest analyst on the Street to recognize the metamorphosis, and my favorable opinion shift proved to be an insightful call. It was a winner for years. Conversely, the worst nightmare for an analyst is having a recommendation go wrong. All analysts vividly remember their bad picks.
The perks of an analyst’s job are not bad either. The best place on earth for golf is Augusta National in Georgia, the site of the Masters tournament. Even for Tiger Woods or Jack Nicklaus, that place is sacred. The ghosts of legends like Bobby Jones and Ben Hogan haunt the fairways. So you might imagine the awe that Augusta inspires in a mediocre duffer like me. When the chairman of an Atlanta-based software firm, John Imlay, part owner of the Falcons NFL football team, inquired about my availability to take in a game from the owner’s box, loiter in the locker room, and chat with the coach on the field, I could barely get the yes word out of my stammering lips. And while that was rolling off my tongue, he mentioned as an aside that we would also be motoring to Augusta afterward for a couple days of golf there.
Magnolia Drive, the Butler cabin, dining in the clubhouse, each of the 18 holes that I was so familiar with from TV coverage—the entire venue was a dreamy, mystical ecstasy. Caddies handed us the golf club we were supposed to use, not the one we could hit best given our ability—normal people cannot hit a two-iron. I maxed out my credit card in the golf shop, was told “those green jackets on that rack are for members only,” swiped all the logoed stationery from my room, and feigned a nonchalant demeanor the whole time. My game was atrocious. What do you expect playing on hallowed ground as if in the presence of Divinity? Well, you can see the outing was a highlight in my life, and it was not a bad locale to chat up management.
The most trying aspect for securities analysts on Wall Street is dealing with a sense of vulnerability to anything that might impact the stocks they cover. The fear stems from realizing that at any time during a business day, a company under coverage might announce dramatic, surprising news, such as a shortfall in earnings or loss of a major contract. An analyst in this circumstance must scramble to assess the situation, then jump on a conference call, and respond to an avalanche of inquiries from the sales force and investors. This is difficult enough if the analyst is in the office with all necessary resources at hand. It is a disaster if it happens when the analyst is on a tightly packed all-day client meeting trip, on an airline flight, vacationing on a cruise ship, or on the golf course. Analysts can never relax on days the stock market is open. Even on holiday in August, we monitor our Blackberries or iPhones and call in periodically every business day, just like a doctor on call.
After you appreciate the basic function and role of Wall Street investment analysts, you need the rest of the story—the reality and well-kept secrets of Street research. To be effective, investors need to comprehend how Wall Street operates, to work around it in some cases, and to take advantage of it in other situations. You will be able to invest on a par with the professionals after the strange, deceptive ways of Wall Street are demystified.