Thursday, 20 November 2008

ANALYSIS - As companies go bankrupt, analysts say 'hold'

NEW YORK (Reuters) - Two days after Circuit City Stores Inc went belly up last week, nine of its 14 analysts rated the electronics retailer a "hold".

Most analysts also rated Lehman Brothers' a "hold" a day after the investment bank filed for Chapter 11 bankruptcy protection. On the day in September that Washington Mutual became the biggest bank failure in U.S. history, one analyst still thought it was a "buy."

And just two of the 14 analysts covering Citigroup Inc rated it a "sell" or a "strong sell" on Wednesday, on a day the bank's shares plunged 23 percent.

These snapshots, culled from Thomson Reuters and StarMine data, shows how far behind the curve analyst ratings have often been during what is probably the worst financial crisis since the Second World War.

Despite some bold statements, such as Deutsche Bank AG saying it thought General Motors Corp's shares were worth nothing last week, analyst calls usually lag the news, not the other way around.

"Analysts are doing their research and they come up with conclusions the market has already come to," said Michael Cuggino, portfolio manager for Permanent Portfolio Funds in San Francisco, which oversees $3.2 billion.

"GM is a perfect example of that. If you look at the preponderance of negative news, it's sort of like they stated the obvious."

Troubling news on Circuit City, Lehman and Washington Mutual also percolated for days before they failed. In such cases, common stock shareholders are often wiped out with no hope for recovery.

"You could ask the question: 'Why didn't they change the rating?'" said Alexander Ljungqvist, a professor at the NYU Stern School of Business.

It's a question that is part and parcel of an ongoing debate about the value of stock ratings. Investors tend to be sensitive to changes in "buy", "sell" and "hold" ratings, one clear-cut way analysts can sum up the value of the companies they cover.

But analysts tend to change their ratings well after shares have fallen, said Mark Bradshaw, a University of Chicago professor. "In the case of analysts, they see what the investors are saying before changing ratings."

In October 2007, just 5.6 percent of all analyst calls were "sell" calls, while nearly 49 percent were "buy" calls, according to Thomson Reuters StarMine data.

Exactly a year later, after the index had lost 37.5 percent of its value, 6.7 percent of analysts calls were "sells". Given the grim economic backdrop, that may seem like a small amount of recommendations to sell stocks, but for equity analysts, this is actually quite bearish.

Academics who study securities analysts partly pin the lag on the lengthy bureaucratic process required to change a rating.

They add that analysts are more likely to drop a stock than downgrade it. For example, in October there were 21 analysts covering Circuit City, which then had one "buy" rating and 14 "holds".

Others say the real value of Wall Street analysts is in the depth of their research reports, not in knee-jerk ratings reactions. They point to tightening time constraints on analysts following the profound changes in sell-side research in the past five years.

Sell-side research has been on the downside since 2003, when U.S. regulators pushed brokerages to separate the investment bank from researchers to thwart conflicts of interest and encourage more "sell" ratings.

But by cutting off a direct link to investment banking revenue, the curbs made research departments vulnerable to cuts and brokerages were forced to produce more research with fewer analysts.

Further job cuts in the industry mean analysts will be under tighter time and resource constraints, making it unlikely recommendations will start to precede market news anytime soon.

"I've kind of lost confidence in the industry to reinvent itself," Ljungqvist added.

No comments:

Post a Comment

DISCLAIMER: The author is not a registered stockbroker nor a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity, index or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. The author recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and that you confirm the facts on your own before making important investment commitments.