The Ethics of Analysts

A lot of people know I am not a huge fan of market analyst ratings. Early on in my exploration of the market I thought I wanted to be an analyst as I thought that these people were paid to do great research and really dig deep on companies. I really enjoyed my time as an industry analyst over at Ferris Research and thought that stock market analysts had similar roles. I understood they were financed by the companies they were analyzing, but never thought that the lack of integrity because of that financing would be so poor. Obviously I never went that route.

Instead I dump the money I save up into the investments I research through my ESPP and more sophisticated transactions. Usually this ends up being in areas of the markets that analysts aren't watching or don't have good things to say. Want access to all of my ESPP content? Book, spreadsheets, training videos, and so on? Sign up for the ESPP Wealth mailing list today!

There has been some research into the validity of those analyst recommendations and it seems that when analysts make bad recommendations, they tend to escalate those recommendations instead of admit they are wrong, at least according to a study by Beshears and Milkman titled Do Sell-Side Stock Analysts Exhibit Escalation of Commitment?. They aren't alone though, Stanford's McNichols finds that buy/sell strategies based on analysts recommendations would leave an investor flat (no gain or loss). Then add the transaction fees and the investor would be losing money. This is commonly the logic that is used against technical analysis of markets.

Think about it… if Goldman Sachs is doing ANYTHING to make a buck, why wouldn’t the analysts be in on it? I know separation of analysts and investors is supposed to be in place, but I think that idea is as rigid as our idea of separation of church and state. Of course it doesn’t stop at $GS, it really isn’t any different at the other firms that compete with $GS, it has to be as they have to compete with $GS (remember that logic came straight from the investment banking executives to explain the 2008 crash - including my old boss Kerry Killinger).

Todd Sullivan recently went on a rant about this regarding Salesforce.com analyst calls and how they feed into the hands of the executives running the calls. Please don't think this is a unique analysis from Todd or a bashing of $CRM. Here is a write-up that Eric Jackson did for The Street. Eric analyzed the $RIMM analyst calls and found that the analysts with the higher stock price recommendations were primarily the ones dishing out questions on the calls. The message? If you over-estimate my stock price, you get priority. Barel Karsen points out a rather comical analyst justification regarding a hold recommendation for Berkshire Hathaway stock... “It’s the cheapest that I’ve seen it in a while. It’s hard for me to get really positive on that.”

I don't think $BRK.A, $CRM, & $RIMM are unique cases, this research that Barry Ritholtz put together shows that most analysts are striving for the most far out estimates 2x or more...

Seriously - from 23% all the way up to 40%!!
Looking at the success rate of predictions, it seems that research into insider buying is more accurate than the predictions of stock analysts. Kind of makes you wonder why insider buying/selling is ignored so much in the media. It also makes you wonder why startups like Estimize took so long to be created.

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