Sunday, November 16, 2008

Of Equity Analysts

In my line of work, I come across a number of equity analysts who religiously cover the stocks of various companies. In thier later twenties, thirty somethings, mostly just sit in their cabins, make a few phone calls and pen down their analysis religiously, quarter after quarter. And then there are those who send people to spy on the business, talk to customers and try to pry out more information from the management than what is discolsed publically. They do a great job of spreading the information. This is the good part, but that its. There are various shades of grey, some darker than the others.

All of them distill this information overload and predict what the company is likely to do in terms of revenues, margins and profits in the next quarter basis which they put a number as price target for the price of the stock in three years. They punish the management if the results end up being lower than that and reward the management if they end above it. 

Well what is wrong with this, is what one may ask? 

Nothing directionally but the number in question is the probelm The number is picked at random and long term assumptions are put in at random to justify the number. The number itself depends on the analysts disposisition towards the company, what side of the bed he woke up that day. Worse is, I have to put a sell on XX% of stocks on my coverage portfolio. 

The more, I try to make sense of these the more I find that there is no logic to these. However, every report is filled with post event logic of what happened and how their number is justified. Everything backed by post fitting of (often subtly twisted) logic. In times of volatile markets such as today, the variations are so huge that they are not even funny. The other day I say a report which downgraded price target of the stock from 450+ to 54 in one single sweep. the near term projections were not nearly as different. 

Some time back, I had come across research which found out a huge amount of correlation between the accuracy of projects by sell side analysts with whether the CEO and the analyst went to the same business school.

Another thing which strikes me. The management is punished for results not matching to guidance. The analysts almost butcher a management which promised 70% growth and showed only 60% . This has almost become a game (And only a few have mastered this).

What sickens me sometimes is the confidence with which these guys pronounce their judgements. Or are they playing liars poker. Notwithstanding the fact that their predictions never came true or at least a majority of them. 

Dont they have a fuduciary responsibility to the investors they sell their research too. 
Ooooooops! I guess there lies my fallacy. Most of these guys' research is not paid for. The brokerages make money only when they execute trades for these investors. 

Classic case of agency problem. 

PS: This is not true of all the analysts. Many, I know are the most hard working and well meaning professionals I have ever met. 

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