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VINE VOICEon 20 September 2008
Investment notes put out by Wall Street analysts are always open to questioning. In his pre-9/11 look at the world of Wall Street analysts, Benjamin Mark Cole - a financial journalist with over 25 years of experience - makes his case that Wall Street analysts are not quite the independent and objective stock pickers that they claim to be.

Via Pied Pipers of Wall Street, Cole seems to suggest that economics of the securities business in the present climate simply dictates that analysts bring in huge underwriting fees for their employers. That, in truth comes from investment bankers, rather than from individual investors whose retail commission is all but a mere fraction of revenues for brokerage houses.

The author also opines that some analysts make the "best case" for a particular stock by regurgitating the latest line from the company itself. As their respective firms chase investment bankers, Wall Street analysts tout stocks that may be poised for a fall and sandwiched in the middle is the gullible ordinary investor, says Cole. One must remember that this book was written prior the collapse of Enron and Worldcom. In that there is some resonance of Cole's conjecture.

It is pleasing to see that this book includes several studies that show the weaknesses of both the estimates and recommendations of analysts. Although all of the material is accurate according to my investigation; there is one caveat. A marginal problem this book has is that it views what is going on from the outside in, rather than inside out. Some chapters of this book standout above the others. For instance, Chapter 2 titled "An Industry transformed: From sleuths to salesmen", speaks for itself. Chapter 7 titled "The Good Guys" offers advice on where investors can turn to for good analysis and guidance. Overall it offers, a sound view of Wall Street brokerage firms, their analysts and how conflict of interest is perceived to be routine in the securities business.
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Let the investor beware of sell-side analyst recommendations!
This book is a little late in arriving. Ten years ago few reporters and almost no individual investors understood that brokerage firm analysts got a lot of their income for bringing in investment banking business (IPOs, mergers, debt financings, and fair value opinions). Then Wall Street Journal reporter, John Dorfman, broke the story. In the old days, sell-side analysts were supposed to be ignorant of what was going on with investment bankers (the so-called Chinese wall) so that the analysts could write objective reports without being compromised by inside information. That Chinese wall doesn't really exist any more.
More than ten years ago, few institutional portfolio managers and buy-side analysts paid much attention to what sell-side analysts have to say. They pay even less attention now.
Since then, regulators have swooped down to require Wall Street brokers to change their practices. But, you'd better assume that the deal is still rigged against you.
As the book points out, a sell-side analyst "is just a banker who writes reports." Those reports usually just regurgitate the latest line from the company.
Mr. Cole embroiders the consequences of this long-past fundamental shift with a history of how investment banking fees came to dominate the securities business relative to trading commissions, scam artists posing in different roles, underwritings of lousy companies that later failed, the nasty tricks of short sellers, and how institutional investors can make a few bucks from flipping IPOs.
Although all of the material is accurate, the book's other problem is that it views what is going on from the outside in, rather than the inside out. A lot of the mistakes that happen occur because everyone relies on the companies to explain what earnings will be (thanks to Regulation FD), analyst coverage is very thin, and many analysts are extremely inexperienced. These "analysts" will become even more investment banker-like in the future. What temporarily resuscitated the role of the sell-side analyst as stock picker was the arrival of the on-line individual trader during the Roaring 90s. A long bear market will continue to undermine any economic role for sell-side analysts other than as advisers to company executives. Most CEOs still think that sell-side analysts are important (mostly because of the short-term momentum reports can temporarily create) and court them. Mr. Cole failed to pick up on this point. That's the reason why Jack Grubman at Solomon Smith Barney made $25 million in one year. Was he worth it? You decide.
I was pleased to see that the book included several studies that showed the weaknesses of both the estimates and recommendations of sell-side analysts.
Will the financial media continue to flock to sell-side analysts? Darn right they will. Everyone else in the industry has real work to do, and there's lots of air time to fill up.
Where else is advice not very helpful? How much do you rely on used car sales people? Vinyl siding sales people? Fortune tellers?
Look straight at the facts . . . and take the right action. Be sure to read John Bogle's book, Common Sense on Mutual Funds, if you want to beat almost all other stock investors.
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