Wisdom Without Waiting: Wall Street Analysts or Witch Doctors?
© John L. Mariotti 2001
These days many managers start or finish their days by checking the stock market. Others have the current stock prices sent to their cell phones or PDAs. With the growth of 401(k) and individual stock market investors, stock price fluctuations get more and more attention. Stock prices gyrate wildly based on the most recent quarterly earning meeting or exceeding analysts' expectations, But who are these analysts anyway?
In my career, I have had to occasion to know quite a few analysts, and be grilled by some of the best. As in all things, the variability in analysts is enormous. Some of the best dig and compute, analyze and apply judgment to come up with uncanny estimates of the operating details of companies. This is a true skill and analysts of this type are usually the ones that provide wonderful insights into a company's performance and hence the outlook for its stock.
The problem is that in stock analysts, just like in many other fields, for every great one, there are many mediocre or poor ones. Few of these analysts have ever spent a moment really working in a company like those they follow. Fewer still have ever run a business, made a payroll, hired or fired people, or done any of the things they talk about so glibly. More of them are well trained "theoretically" but not practically. The saying that comes to mind is, "In theory, there is no difference between theory and practice. In practice, there is a lot of difference".
There are also analysts who have become disciples of a Larry Ellison quote I once read: "if you say something often enough, it becomes the truth". Now I know Ellison (Oracle's Chairman) is a brilliant person, so he probably had his tongue firmly planted in his cheek as he said this. But far too often, security analysts who are also part of investment banking firms catch this disease. They become so enamored with the wonder of their (recommended) companies that they lose all sight of reality,
Companies, on the other hand, jump through hoops to exceed these "analysts expectations". Most the analysts relate their expectations to year-to-year and quarter-to-quarter earnings comparisons. If this were a perfect world, that would be a perfect measure-but it isn't. Markets have ups and downs, some of them so severe that the companies holding large market shares cannot "smooth earnings" unless they have a bag of money (and a bag of tricks) or a very profitable and diverse portfolio of divisions-like GE. GE may deny it, but most experts believe it uses its vast portfolio of profitable and interconnected companies and "cash hoards" to smooth out normal market fluctuations-and Wall Street loves it.
Now here's the rub. In primitive days, tribal witch doctors painted their faces, wore outlandish costumes, sprinkled powder into a fire and muttered unintelligible incantations to the "gods". Sometimes, they were lucky, and the gods did what they asked for-so they took credit for it. When nothing happened, the witch doctors opined that "the gods must be angry" and ordered more sacrifices. Doesn't that sound a lot like analysts? Maybe we should get analysts to paint their faces!
How many "Sell" ratings have you seen lately? None? How many ways do they have to say "buy"? Let's see, there is "Buy", Strong Buy", "Accumulate", and probably a couple of others like "out-perform" and "market performer"-whatever those mean to investors. A "Hold" is really a "Sell", in disguise.
Why? Because analysts thrive on access to company information, and if they start downgrading companies, their information stream-their precious knowledge-from the company dries up, that's why. Believe it. I have been in meetings where that discussion was held, and that is what happens.
Let's sum up. Analysts are in business to trade stocks or make stock deals. They are employed by either brokerage firms or investment banks, both of which have vested interests in stocks/companies being bought and/or sold. So these guys are purely objective and independent, right? Duhhh?
Companies know there are market fluctuations in their industries and do crazy things to pump up quarterly earnings. They do things like pulling ahead orders, mortgaging the future (does Lucent come to mind), giving deals on prices, financing, dating, or making "bill and hold" sales to reach the quarter's goals. ("Chainsaw", where are you?) Goals that were set by whom? Shareholders? Nooo! The board? Nooo! Analysts? Right-o!
And where did these analysts get the knowledge, experience and wisdom to set these targets? Well, if you know or can find that answer, you don't need to be reading this. Who suffers? Almost everybody-and in some cases even the analysts. Some of the most "brilliant" during the dot-com debacle are now in deep doo-doo. And they deserve it. Bottom line: don't invest in anything you don't understand. If it doesn't make sense to you, it probably doesn't make sense. And don't, believe what "all the analysts say"-because they are mere mortals too, and like the Witch Doctors, they will be wrong and you will suffer.
