When You
See A
Stock Analyst On TV
Hit the Mute Button
By Donald Rowe, editor
The Wall Street Digest
Major
brokerage firms on Wall Street have a serious conflict of interest
problem. Morgan Stanley and Merrill Lynch are the world's number
one and number two investment bankers. As such, they make far
more money bringing new companies (IPOs) to the public marketplace
than they could ever make on the brokerage side of the business.
Very courageously, Individual Investor magazine published
the first article that revealed how badly Wall Street's most
famous stock analysts have led investors astray.
The following article,
very appropriately titled, "Hall of Shame," was
published in the February issue.
"A lot of stocks
that analysts urged people to buy last year turned out to be
terrible investments. Whose advice provided the most disastrous?
To find out, we went to longtime CNBC reporter David Faber, known
for his outspoken criticism of Wall Street's objectivity problem.
Almost by definition
these days, analyst is a stock booster. But were there some standouts
last year?
Yes, four of them,
all celebrity tech analysts, In fact, my first Hall of Shame
choice is known as the Queen of the Internet Mary Meeker of Morgan
Stanley Dean Witter. More than most analysts, she has been heavily
involved in the investment banking side, helping MSDW take Internet
companies public a very lucrative business. When these stocks
started trading, she hyped them in reports to the firm's sales
force.
She became identified
with the rise of the dot-com culture because of the enormous
influence she could bring to bear, both in raising capital and
affecting stock prices.
She said losses didn't
matter because the Net companies were building critical mass.
We all realize now, and she may have recognized it herself at
the time, that the dot-com phenomenon was simply a speculative
bubble. What was her worst call? Priceline.com. She was hawking
it last spring when it traded at around $100. Now it's at $2.
(The Wall Street
Digest repeatedly warned subscribers against the dot-coms
and companies without earnings.)
Your next choice?
Another Internet bull. Henry Blodget made his name at a small
firm, CIBC Oppenheimer, by rightly predicting that Amazon.com,
then trading at $209 (December 1998), would hit $400 within a
year. When the stock reached that target in only three weeks
and continued rocketing to $600 ($106 on a split-adjusted basis),
his status as a seer was set.
Merrill Lynch hired
him, then he championed no-profit e-commerce companies, bending
over backwards to justify outrageous valuations.
He had to know the
analytical tools he was using were absurd. At that time, it was
pure momentum psychology. He's not stupid. Besides Amazon, now
at $23, what were some of his biggest bombs? Last March, he gave
VerticalNet a target of $350. It trades for $9 now. In February,
Merrill Lynch took Pets.com public at $11, and a month later
Blodget said it would hit $16 in 12 to 18 months. By November,
it was out of business.
Who's the third nominee? Dan Niles. Of all analysts, he was the most bullish
on semiconductors.
When he was at Robertson
Stevens, he was willing to go negative on occasion, and he made
a reputation partly because of that. Then, after he was hired
by Lehman Brothers, reportedly at a huge salary, he turned wholly
positive. Why? Because at a big firm like Lehman, there's a lot
more opportunity to garner the investment banking business.
Which stock is Niles
most closely associated with? Intel.
When he was still at
Roberston Stephens, at a time when many were promoting the stock,
he was negative, and rightly so. But when he moved to Lehman,
he became 100% positive. Only on November 30 did he downgrade
Intel, which by then had fallen from $75 to $35. It bottomed
out at $31. The Wall Street Digest has not recommended
Intel because the Computer Revolution is over.
We continue to recommend
that you sell Intel, Dell, Compaq, Apple, Gateway, etc.
Have you saved the
best for last? Yes. It's Jack Grubman, who openly wears two
hats as an investment banker and a stock analyst. One thing that
had given him some credibility, aside from his many insightful
remarks about the telecom industry in general, was that he was
negative on AT&T for years. And with good reason. Then, in
the fall of 1999, his firm, Salomon Smith Barney, went after
the underwriting business about to be generated by AT&T's
huge spin-off of its wireless unit.
Suddenly he was positive
on AT&T, and, sure enough, when the IPO happened, Salomon
was a leading participant.
That means tens of
millions in investment banking fees. He remained bullish on AT&T
through most of its decline in 2000, downgrading it only in October,
when it had already fallen by half.
Is AT&T his only
bad call? No. His entire telecom group Worldcom, Global Crossing,
PSINet, Rogers Wireless, ICG Communications eventually blew up;
but he didn't downgrade anything until it had fallen 70% or so.
ICG even went bankrupt. During the carnage, he wasn't there to
help investors protect their money. (The Wall Street Digest
recommended that subscribers and clients sell AT&T, Sprint
and Worldcom because the long distance business was shifting
to the Internet. Also global E-mail is free. It is still not
too late to sell AT&T, Sprint and Worldcom).
So whom can investors
trust? Should they ignore analysts? I'd severely discount advice
from large firms that do both banking and analysis.
Smaller firms, such
as Sanford C. Bernstein, do little or no banking and have to
sell their research in order to obtain revenue, so they're much
more reliable. Small firms also tend to hire younger analysts
who don't know enough not to try to find out bad things. That
said, analysts at the big firms can be useful when they report
on general conditions within a sector they really understand.
Dan Niles, for example, was an engineer at Digital, and he knows
semiconductors inside out.
But I would caution
the investor never to rely solely, or even primarily, on an analyst's
opinion, no matter what company that analyst works for."
(Source: Individual
Investor, February 2001.) David Faber, who wrote for Institutional
Investor before joining CNBC, will publish his first book
this fall, tentatively titled, "The Truth About Wall Street."
Since this initial
article appeared, a flood of articles has been published by various
newspapers and magazines that reveal how recommendations by stock
analysts are influenced by the quest for investment banking profits.
The Sunday New York Times, for example, published
a major front page story that described in detail how Henry Blodget
of Merrill Lynch continued to recommend Internet stocks even
while they relentlessly plunged in price throughout 2000.
Not surprisingly, Henry
Blodget has virtually disappeared.
Merrill Lynch paid
Blodget millions to hype stocks that benefited the investment
banking side of the business. Clients of Merrill Lynch are furious.
They listened to Blodget and lost millions by purchasing stocks
without earnings. How many of Blodget's recommended companies
are now out of business? Merrill Lynch does not want you to know.
Since January of 2000, over 500 dot-com companies have closed
their doors.
The May 14th issue
of Fortune magazine is must reading for every investor.
While Mary Meeker's
picture stares at you on the cover, the headline boldly asks,
"Can We Ever Trust Wall Street Again?" The feature
article describes in detail "Where Mary Went Wrong."
Fortune editor, Peter Elkind, wrote the following: "Today
Meeker, 41, has become the single most powerful symbol of how
Wall Street can lead investors astray. For the past year, as
Internet stocks have crumbled and entire companies have vaporized,
Meeker has maintained the same upbeat ratings on her companies
that characterized her research reports in the glory days. For
instance, of the 15 stocks Meeker currently covers, she has a
strong buy or an outperform rating on all but two.
Among the stocks she
has never downgraded are Priceline, Amazon, Yahoo!, and Free-Markets
all of which have declined between 85% and 97% from their peak.
For this, she has been
duly pummeled in the press, accused of cheerleading for Morgan
Stanley's investment banking clients. But Meeker's refusal to
downgrade her stocks only a small piece of a bigger story. Meeker
came to see herself not merely as an analyst, but as a player
a power broker, a deal maker, a force to be reckoned with. She
was a true Internet insider. As a result, Meeker did things that
utterly compromised her as a stock picker.
In responding now to
criticism that she let investors down, Meeker refuses to admit
or even see how compromised she is.
She defends herself
in part by saying she feels protective toward the phenomenon
she helped launch and especially toward the dozens of companies
she helped Morgan Stanley take public. `There is something compelling
aboutplaying an important role in something that will never happen
againI feel a stewardship is a strong word but I felt a keen
sense of responsibility.' She adds, `If you take a company public
and you are really aggressive on the downside, it can be devastating.'
Of course, if you are
not aggressive on the downside, it can be devastating for investors.
But that was never
a Meeker priority. Though it is hardly news anymore that the
Chinese Wall once separating investment banking from Wall Street
research has eroded, what you realize in talking to Meeker is
the extent to which these two supposedly conflicting functions
keeping companies happy and giving investors honest stock advice
are now organically intertwined.
She talks unashamedly,
for instance, about how she has used her research to help land
banking deals for Morgan Stanley.
And she describes how
upset she became when Morgan Stanley lost a hotly contested deal
to archrival Goldman Sachs. `I had never lost an IPO mandate
in my life for a company that I wanted to take public,' she says,
sounding like, well, an investment banker. The essential charge
that has been hurled at her this past year centers on her refusal
to downgrade her stocks, even as they dropped 70%, 80% more than
90% in some cases.
In effect, she's being
accused of selling-out investors to keep Morgan Stanley's banking
clients happy.
In the New York
Times last December, Gretchen Morgenson noted that Meeker
had an outperform rating on all of her Internet stocks down an
average of 83% and pointedly asked a Morgan Stanley PR official
whether `her nonstop optimism had anything to do with the fact
that most of the companies had engaged Morgan Stanley as an investment
bank.'
The dot-com stocks
she is most closely associated with such as Priceline, Yahoo!,
and Amazon have been disasters in the past year.
Yet, even now Meeker
is not ready to concede that these stocks are disasters, even
with Priceline at $4 (from $162), Yahoo! At $19.40 (from $237),
and Amazon at $15 (from $106). On the contrary, she insists that
they still deserve their outperform rating. The most critical
point is this: Mary Meeker got so caught up in the allure of
the Internet the celebrity, the money, the thrill of deal making
that she forgot she was supposed to be analyzing companies.
She had no idea what
the fundamentals were.
Thus, when a company
like Priceline turned out to have serious problems, including
its disastrous foray into gasoline and groceries, Meeker didn't
have a clue. Even so, she maintains her outperform rating on
the stock." Last year, Morgan Stanley paid stock analyst
Mary Meeker $15 million. Was she worth it? You bet. Even though
investors lost millions following her advice, Morgan Stanley
reaped billions from investment banking deals generated from
her recommendations.
The following paragraph
appeared on page two of Investors Business Daily on March
22nd:
J.P. Morgan analysts
needs OK from clients, bankers. The brokerage's top equity
researcher, Peter Houghton, told analysts in a memo they must
clear stock recommendations with corporate clients and investment
bankers at J.P. Morgan. The Times of London reported.
He also said he `must personally sign-off on all recommendations.'
This is the best example I have ever found of the fox guarding
the chickens. Sadly, the full story of this memo appeared only
in the Financial Times of London.
Why didn't the financial
media in the U.S. pick up the story? The possibility of losing
J.P. Morgan's advertising revenue was perhaps a factor.
On April 26th, Investors
Business Daily (IBD) published this paragraph on its page
two news summary: "A full 88% of brokerage analysts said
the companies they cover would retaliate against a sell recommendation
by cutting their firms out of stock offerings and merger deals,
a Reuters' survey found. Only 1% of all recommendations are sells."
You and I will never
know how many stock analysts have been fired after a sell recommendation
infuriated a company CEO, who then moved the banking business
to a "more co-operative" brokerage company.
On May 17th, IBD published
the following paragraph, again on its page two news summary:
"Analyst System is Broken. Conflicts of interest
and other problems lead to biased research that can cost investors
dearly, Precursor Group said. Only 1% of 28,000 stock recommendations
in 2000 were sell," says First Call, even as the Nasdaq
dived nearly 40%.
Precursor said analysts'
pay is often driven by investment banking deals, creating a conflict
between the responsibility to investors and to the firm's clients."
Individual Investor,
Fortune, The New York Times and Investors Business Daily
are reporting the truth about Wall Street at the risk of
losing millions in advertising revenues from Wall Street's biggest
brokerage companies. Hopefully, the net result will eventually
be an SEC probe of Wall Street's investment banking practices.
Although Henry Blodget of Merrill Lynch and Mary Meeker of Morgan
Stanley are at the top of Wall Street's Hall of Shame list, there
are thousands of honest stock analysts.
Charles T. Maxwell,
Senior Energy Analyst with the Weeden Company, is at the top
of the list of Wall Street's most respected analysts.
Everyone, including
the Federal Reserve Board, listens to his views on where energy
prices are headed. Individual Investor magazine listed
seven analysts who "Got It Right" in 2000 by boldly
saying sell when everyone else was still crying buy:
- Jonathan Cohen, Internet Analyst with Wit SoundView
- Jonathan Joseph, Semiconductor Analyst with Salomon Smith Barney
- Thomas K. Brown is a hedge fund manager now, but was fired by Donaldson Lufkin Jenrette (DLJ) after he downgraded First Union bank from buy to neutral. After he and First Union's CEO Edward E. Crutchfield had words, First Union stopped doing investment banking with DLJ, costing some $10 million to $20 million a year. Brown was fired a month later, in March 1998.
- George Stachan, Retail Analyst with Goldman Sachs
- Robert Olstein, Manager of the Olstein Financial Alert Fund
- Ravi Suria, Debt Analyst with Lehman Brothers
- Donald Luskin, Co-manager of the Openfund
All
seven of the analysts mentioned above risked their jobs by releasing
correct sell recommendations.
WSD Editor's Note:
During 2000, The Wall Street Digest had its share
of honest disappointments during the worst stock market environment
since the 1970s. There is simply no way to avoid disappointments
in the stock market. That is why we issue sell signals! However,
it is clearly wrong and dishonest for the brokerage side of a
company to deliberately recommend bad stocks in order to allow
the highly profitable investment banking side of the company
to dramatically increase the firm's net profits.
Brokerage companies
should be required to disclose investment banking relationships
when a buy recommendation is deliberately designed to capture
the same company's investment banking business. Ever notice the
brokerage side of a company seldom issues sell signals? That's
because they may drive away highly profitable investment banking
business.
Individual Investor
publisher, Jonathan Steinberg deserves a Pulitzer Prize for
telling the truth about Wall Street's big brokerage companies.
The following paragraph
appeared on the page two news summary of Investors Business
Daily on June 13th: "Congress to Scrutinize Analysts.
A House subcommittee will hold a hearing to probe how independent
stock analysis actually is. Brokerages rely on huge investment
banking fees from stock and bond offerings and mergers. Not surprisingly,
analysts rarely issue negative reports on companies.
An industry trade group
announced a ban on linking analyst pay to investment banking
deals to deflect criticism and possible legislation."
A Congressional investigation
is welcomed, but where is the Securities and Exchange Commission
(SEC), whose primary function is to protect the individual investor
from fraud and deceptive practices. Investors should write their
Congressman and the SEC to demand appropriate action.
Editor's Note: Donald
Rowe is editor of award-winning The Wall Street Digest,
One Sarasota Tower, Ste. 602, Sarasota, FL 34236, 1 year, 12
issues, $150. Published continuously since 1977, The Wall Street
Digest is one of Wall Street's most widely read investment and
financial publications for economic trends and investment direction.
This highly-regarded advisory newsletter provides specific investment
advice for stocks, bonds, mutual funds, precious metals, stock
and bond markets. Mr. Rowe is an economic and investment advisor
to bankers, brokers and investors in the U.S. and 29 foreign
countries. Visit the Web site at www.wallstreetdigest.com.
