Investors urged to be more cautious, rely less on analysts after Enron, dot-com crashes

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Posted 2:49PM on Monday, February 18, 2002

NEW YORK - Investors who are thinking of buying a stock don't typically pore over annual reports, chart a company's performance over time, or forecast its earnings growth before making their trades. They certainly don't visit corporations before adding or removing shares from their portfolios. That's what stock analysts are for. But analysts' recommendations -- to buy, hold or sell -- aren't always on the money, and the rating process itself is flawed. Investors were reminded of that fact following the collapse of Enron Corp -- many analysts maintained positive ratings on the energy trader right up to to Dec. 2, when it filed the largest U.S. corporate bankruptcy petition. And analysts were already sharply criticized for their handling of Internet stocks before and during the dot-com crash. Professors who study the investment business say the public needs to take some responsibility and not rely on analysts' assessments alone when they buy or sell stocks. "If investors just trade on the headlines, they deserve what they get. There is more to this stuff than a simple upgrade or downgrade" in stock ratings, said Charles Jones, a professor of finance at Columbia University's Graduate School of Business. Acknowledging the importance of understanding analysts' recommendations, the National Association of Securities Dealers last week posted a primer for investors on its Web site (www.nasd.com). The "Guide to Understanding Securities Analyst Recommendations" explains issues of conflict, offers suggestions for comparing various firms' ratings systems and urges investors to consider several recommendations and to do their own research. Analysts who work for investment firms have long been criticized for inflating ratings -- issuing "buys" and shying away from "sell" -- so their firms won't lose lucrative investment banking business. Many analysts are also concerned that if they issue a negative rating on a company, they'll be deprived of the financial information needed for their research. Positive ratings far outnumber the negatives. According to Thomson Financial/First Call, 26.3 percent of stock ratings currently call for "strong buy"; 36.4 percent for "buy"; 35.6 percent for "hold"; 1.3 percent for "sell"; and 0.5 percent for "strong sell." Aware of the game, Wall Street professionals have learned how to interpret the ratings, said Chuck Hill, director of research for Thomson Financial. "They know that `hold' really means `sell.' ... It's kind of an understood thing," Hill said. "Analysts don't want to offend the company and jeopardize the investment banking business." Critics of the system say the individual investors need to be savvy, too. "It's an elaborate con game," said Robert Z. Aliber, professor of international economics and finance at the University of Chicago Graduate School of Business. In the late '90s, technology analysts like Merrill Lynch's Henry Blodget and Mary Meeker of Morgan Stanley Dean Witter urged investors to buy, and "the analysts' names started carrying weight in the marketplace," said Kathy Waldron, dean of Long Island University's School of Business. "Companies wanted the big-name analysts to look at them. It is sort of the Hollywoodization of analysts. Whoever heard of analysts before?" she said. Individual investors, witnessing stock prices soar, got caught up in the hype too. Aliber faulted them for not being more prudent. "Everyone became infatuated with the fortunes to be made in the stock markets," he said. Waldron agreed, and also said investors should do more research before they trade. "I always tell my students, `If you haven't read the last three annual reports for a company, why would you buy it?'," Waldron said. "Sure, it's history, but you can see if what management said was happening with the company came true." "They are experts in their field," Waldron said of stock analysts. But, "Would I ever rely on just one analyst? No."