Home > Articles > Business & Management > Finance & Investing

  • Print
  • + Share This
This chapter is from the book

The Biases of Analysts

Be aware that securities analysts are human, and thus they are influenced by the same psychological biases and emotions as the rest of us. They tend to follow a specific industry and get attached (see attachment bias in Chapter 2, "Behavioral Finance") to the firms in that industry. Despite their rigorous training in stock valuation, analysts can completely disregard traditional theory during periods of stock market mania. During the tech stock bubble, most analysts encouraged the purchase of stocks that already had prices over 10 times their reasonable value. For example, making aggressive and optimistic assumptions in traditional valuation models, DoubleClick, Inc. was worth less than $7 per share in late 1999 and early 2000. Its stock price was over $120 per share. Yet, analysts were forecasting even higher prices and recommending a Strong Buy. Indeed, by mid- to late 2001, the stock was trading in the much more appropriate $7 to $10 range. Of course, this wasn't good for investors who bought DoubleClick at $100 per share (or more) based on those recommendations.

The changing financial environment of the 1990s has caused (or made worse) a conflict of interest for analysts. Most financial firms earn their income from three sources: (1) investment banking, (2) brokerage services, and (3) proprietary trading. Proprietary trading is the trading and investing of the firm's own money. Brokerage services are the fees generated from the activities of other investors, like commission fees and market-making activities. Competition from the rise of discount brokerages in the 1980s and the deep discount online brokerages in the 1990s reduced this income for traditional financial firms. The largest source of income is the investment banking activities, which include helping firms issue stocks, bonds, and other securities. The fees from helping a firm go public in its initial public offering (IPO) can be in the tens of millions of dollars.

Consider what you would do if you were a company hiring an investment bank to help issue some securities. You can hire Morgan Stanley, whose analyst rates your firm a Strong Buy, or you can hire Merrill Lynch, whose analyst rates your firm a Strong Sell. Which do you chose? Morgan Stanley would get the business every time. Since the fees are so large, the investment-banking segment of the firm puts pressure on the analysts to rate firms highly so that they can get the IPO and other investment banking business.

Indeed, an analyst that gives a firm a poor rating will get attacked on multiple fronts. First, the company may retaliate by limiting the analyst's access to information about the firm in the future. Then the company may pull its business from the analyst's firm. Also, other clients of the analyst's firm may complain because they own the stock and it now has a poor rating.

Of the 39,972 analyst recommendations made in 1999, only 1,173 (or 2.9%) recommended investors sell a firm. Contrast this with the 27,654 (69.2%) recommendations to buy a firm. Note that this was at the peak of the tech bubble in the stock market. When the collapse was occurring, one year later, the recommendations were still nearly identical: 70.8% buy and 1.8% sell. The analyst recommendations seem to have had little to do with market conditions. Additionally, a recommendation to buy a stock is not that remarkable.

The bias of analysts can be seen quite clearly in those firms that have recently gone public with an IPO. Consider the 391 firms that went public in 1990 and 1991. When an investment bank helps a firm conduct an IPO, the bank is called the underwriter. To keep a good reputation as an underwriter, the investment firm will sometimes work to support the price of the IPO shares when they weaken. For example, an analyst for the underwriter may issue a Buy recommendation for the IPO firm after the price has slipped in hopes that the recommendation will generate more buyers and increase the stock price. Indeed, when an analyst associated with the underwriter initiated a Buy recommendation on an IPO firm, that IPO firm experienced an underperformance of the market by an average 1.6% in the prior month.3 Are these firms really good to buy? Actually, they continue to underperform the market by 5.3% for the next year. On the other hand, prior performance of IPO firms that non-underwriter analysts recommended beat the market by 4.1% the month before the recommendation and continued to beat the market during the next year by an astonishing 13.1%. It appears that the conflict of interest that analysts face when their employer conducts business with the firms they follow creates biased and poor recommendations.

To illustrate these points, take the behavior of Morgan Stanley's analyst superstar, Mary Meeker. Her frequent appearance on financial television, like CNBC, and her relentless doling out of bullish recommendations on Internet firms dubbed her the Queen of the Internet. By 1998, the prices of these firms far exceeded any valuation rationally computed using traditional methods, so she invented new methods.4 When the profits of the firm can't justify its price, switch to sales. When sales can't justify the price, switch to the number of eyeballs (number of Web page viewers). When the price of the stock achieves the target price, raise the target price. Of the 11 firms she recommended as a Strong Buy, her employer had underwritten eight. Indeed, Morgan Stanley grossed between $500 million and $1 billion in investment banking fees during the Internet IPO mania. At the end of 2000, the tech stock bubble had collapsed. Her 11 recommendations averaged a –83% return, yet all retained a Strong Buy rating. They declined further in 2001.

This conflict of interest faced by analysts has drawn the attention of both the Securities and Exchange Commission (SEC) and the U.S. Congress.5 The SEC has been considering bringing charges against some analysts who were selling stock from their own accounts while publicly recommending other investors purchase those stocks. Congress has been holding hearings on analyst credibility.

  • + Share This
  • 🔖 Save To Your Account

InformIT Promotional Mailings & Special Offers

I would like to receive exclusive offers and hear about products from InformIT and its family of brands. I can unsubscribe at any time.

Overview


Pearson Education, Inc., 221 River Street, Hoboken, New Jersey 07030, (Pearson) presents this site to provide information about products and services that can be purchased through this site.

This privacy notice provides an overview of our commitment to privacy and describes how we collect, protect, use and share personal information collected through this site. Please note that other Pearson websites and online products and services have their own separate privacy policies.

Collection and Use of Information


To conduct business and deliver products and services, Pearson collects and uses personal information in several ways in connection with this site, including:

Questions and Inquiries

For inquiries and questions, we collect the inquiry or question, together with name, contact details (email address, phone number and mailing address) and any other additional information voluntarily submitted to us through a Contact Us form or an email. We use this information to address the inquiry and respond to the question.

Online Store

For orders and purchases placed through our online store on this site, we collect order details, name, institution name and address (if applicable), email address, phone number, shipping and billing addresses, credit/debit card information, shipping options and any instructions. We use this information to complete transactions, fulfill orders, communicate with individuals placing orders or visiting the online store, and for related purposes.

Surveys

Pearson may offer opportunities to provide feedback or participate in surveys, including surveys evaluating Pearson products, services or sites. Participation is voluntary. Pearson collects information requested in the survey questions and uses the information to evaluate, support, maintain and improve products, services or sites, develop new products and services, conduct educational research and for other purposes specified in the survey.

Contests and Drawings

Occasionally, we may sponsor a contest or drawing. Participation is optional. Pearson collects name, contact information and other information specified on the entry form for the contest or drawing to conduct the contest or drawing. Pearson may collect additional personal information from the winners of a contest or drawing in order to award the prize and for tax reporting purposes, as required by law.

Newsletters

If you have elected to receive email newsletters or promotional mailings and special offers but want to unsubscribe, simply email information@informit.com.

Service Announcements

On rare occasions it is necessary to send out a strictly service related announcement. For instance, if our service is temporarily suspended for maintenance we might send users an email. Generally, users may not opt-out of these communications, though they can deactivate their account information. However, these communications are not promotional in nature.

Customer Service

We communicate with users on a regular basis to provide requested services and in regard to issues relating to their account we reply via email or phone in accordance with the users' wishes when a user submits their information through our Contact Us form.

Other Collection and Use of Information


Application and System Logs

Pearson automatically collects log data to help ensure the delivery, availability and security of this site. Log data may include technical information about how a user or visitor connected to this site, such as browser type, type of computer/device, operating system, internet service provider and IP address. We use this information for support purposes and to monitor the health of the site, identify problems, improve service, detect unauthorized access and fraudulent activity, prevent and respond to security incidents and appropriately scale computing resources.

Web Analytics

Pearson may use third party web trend analytical services, including Google Analytics, to collect visitor information, such as IP addresses, browser types, referring pages, pages visited and time spent on a particular site. While these analytical services collect and report information on an anonymous basis, they may use cookies to gather web trend information. The information gathered may enable Pearson (but not the third party web trend services) to link information with application and system log data. Pearson uses this information for system administration and to identify problems, improve service, detect unauthorized access and fraudulent activity, prevent and respond to security incidents, appropriately scale computing resources and otherwise support and deliver this site and its services.

Cookies and Related Technologies

This site uses cookies and similar technologies to personalize content, measure traffic patterns, control security, track use and access of information on this site, and provide interest-based messages and advertising. Users can manage and block the use of cookies through their browser. Disabling or blocking certain cookies may limit the functionality of this site.

Do Not Track

This site currently does not respond to Do Not Track signals.

Security


Pearson uses appropriate physical, administrative and technical security measures to protect personal information from unauthorized access, use and disclosure.

Children


This site is not directed to children under the age of 13.

Marketing


Pearson may send or direct marketing communications to users, provided that

  • Pearson will not use personal information collected or processed as a K-12 school service provider for the purpose of directed or targeted advertising.
  • Such marketing is consistent with applicable law and Pearson's legal obligations.
  • Pearson will not knowingly direct or send marketing communications to an individual who has expressed a preference not to receive marketing.
  • Where required by applicable law, express or implied consent to marketing exists and has not been withdrawn.

Pearson may provide personal information to a third party service provider on a restricted basis to provide marketing solely on behalf of Pearson or an affiliate or customer for whom Pearson is a service provider. Marketing preferences may be changed at any time.

Correcting/Updating Personal Information


If a user's personally identifiable information changes (such as your postal address or email address), we provide a way to correct or update that user's personal data provided to us. This can be done on the Account page. If a user no longer desires our service and desires to delete his or her account, please contact us at customer-service@informit.com and we will process the deletion of a user's account.

Choice/Opt-out


Users can always make an informed choice as to whether they should proceed with certain services offered by InformIT. If you choose to remove yourself from our mailing list(s) simply visit the following page and uncheck any communication you no longer want to receive: www.informit.com/u.aspx.

Sale of Personal Information


Pearson does not rent or sell personal information in exchange for any payment of money.

While Pearson does not sell personal information, as defined in Nevada law, Nevada residents may email a request for no sale of their personal information to NevadaDesignatedRequest@pearson.com.

Supplemental Privacy Statement for California Residents


California residents should read our Supplemental privacy statement for California residents in conjunction with this Privacy Notice. The Supplemental privacy statement for California residents explains Pearson's commitment to comply with California law and applies to personal information of California residents collected in connection with this site and the Services.

Sharing and Disclosure


Pearson may disclose personal information, as follows:

  • As required by law.
  • With the consent of the individual (or their parent, if the individual is a minor)
  • In response to a subpoena, court order or legal process, to the extent permitted or required by law
  • To protect the security and safety of individuals, data, assets and systems, consistent with applicable law
  • In connection the sale, joint venture or other transfer of some or all of its company or assets, subject to the provisions of this Privacy Notice
  • To investigate or address actual or suspected fraud or other illegal activities
  • To exercise its legal rights, including enforcement of the Terms of Use for this site or another contract
  • To affiliated Pearson companies and other companies and organizations who perform work for Pearson and are obligated to protect the privacy of personal information consistent with this Privacy Notice
  • To a school, organization, company or government agency, where Pearson collects or processes the personal information in a school setting or on behalf of such organization, company or government agency.

Links


This web site contains links to other sites. Please be aware that we are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of each and every web site that collects Personal Information. This privacy statement applies solely to information collected by this web site.

Requests and Contact


Please contact us about this Privacy Notice or if you have any requests or questions relating to the privacy of your personal information.

Changes to this Privacy Notice


We may revise this Privacy Notice through an updated posting. We will identify the effective date of the revision in the posting. Often, updates are made to provide greater clarity or to comply with changes in regulatory requirements. If the updates involve material changes to the collection, protection, use or disclosure of Personal Information, Pearson will provide notice of the change through a conspicuous notice on this site or other appropriate way. Continued use of the site after the effective date of a posted revision evidences acceptance. Please contact us if you have questions or concerns about the Privacy Notice or any objection to any revisions.

Last Update: November 17, 2020