Masters of the Obvious

Wall Street stock analysts are sometimes helpful but more often are suspect. I won't rehash the many ethical lapses of this industry leading up to the collapse of the Nasdaq and the stock market in general in 2000. Hundreds of millions of dollars of fines were imposed but I wonder how much better it is.

One of the new rules was put in place due to the grivious conflicts of interest with firms recommending stocks for whom they sought or performed investment banking services. The firms are required to disclose if the have or are actively seeking investment banking business with a company for which they provide stock market analysis and recommendations.

How do these Wall Street firms implement this regulation? They simply slap a disclaimer at the bottom of every stock report stating that they may be seeking or intend to seek investment banking work with that respective company. The same statement on every company report. So I don't know any more before I did in 2000.

Through my several brokerage accounts I have access to a number of reports including those from Charles Schwab, Standard & Poor, Merrill Lynch, Goldman Sachs and Morningstar among others.

An exception to the independence issue is Morningstar, since they do not have an investment banking line of business. They have an interesting methodolgy that is very Warren Buffett like. They strongly favor companies with a defensible franchise, or moat. I find that Morningstar is often in disagreement with the other brokerage recommendations on both the buy and the sell side.

One of my frustrations with Morningstar, however, is that as far as I can tell they will not recommend companies in highly cyclical industries. Some of the greatest investing profits can be made in cyclical industries as the normal economic cycles wax and wane.

I do not find Merrill Lynch particularly helpful. I find Goldman Sachs quite good and I trust Goldman Sachs' insight and judgement more than most. When Goldman puts a stock on their "Conviction Buy" list I pay attention. Charles Schwab's rating system seems to mostly be about momentum, and the ratings change a lot. Stocks making strong moves up are upgraded and visa versa, perhaps encouraging more frequent trading and therefore fees to Charles Schwab.

More often than not analysts change ratings and price targets after the fact. I would certainly be more helpful to tell me to "sell" a stock before it drops precipitously. The same goes for telling me when to "buy". A stock will move through a firm's price target by a substantial amount and only then will the price target be raised. Do the work and provide me some actual insight that I can't figure out by myself.

Here is a good one. S&P began coverage of China Life Insurance in mid 2004 with a "hold" when the stock traded for about $10 (split adjusted). Since that time the stock has always been rated either a "hold" or "sell" by S&P. In the big selloff today China Life Insurance closed down more than $6 per ADR (each ADR equals 15 common shares) at $96.54, or a ~950% increase in about 3 and 1/3 years. I've only been in for the last 150%.

Due to copyright restrictions (I don't want McGraw Hill to get grumpy at me) I can't attach S&P's brokerage report here, but let me paint a picture with words. Imagine a 4 year chart where the stock price moves steadily and inexorable from the lower left to the upper right. S&P overlays its price target for the shares over the stock price graph. Amazingly the two are almost the same graph. Each time China Life moves up the target price is raised to match or slightly exceed the price of the ADR.

Is this helpful? Of course that is a rhetorical question. What would be helpful is to recommend a stock that goes up 950% over 3 years before it happens.

China Life Insurance is a play on the emerging Chinese middle class who now have enough disposable income to afford insurance, and enough to protect that they want to buy it. Competition has been heavily restricted in the life insurance industry with China Life being the chosen company. They have taken advantage of these restrictions in terms of brand development and building a country-wide network of dedicated sales representatives.

At this point the stock is not cheap, but it is not in bubble territory either. It is just on the expensive side. I doubt that I would initiate a new position in China Life right now. Even though they continue to grow revenue and income by leaps and bounds a significant percentage is being derived from investments in an admittedly overheating market.

I have no idea why S&P wastes their time with completely unhelpful reports for this stock. Not all of S&P's analysis is so poor. Some is quite good. But their China Life recommendations and price targets are an example of what is all too common in the industry.

One final problem in the stock analyst business is that they are never bullish enough on a sector that is really strong and never bearish enough on a sector that is really weak. The analysts will feel they can not put a sell rating on every stock in a sector, even though that is exactly what they should do. Likewise they feel they can only have so many "buy" ratings in a particular sector, often ignoring stocks that can make you a lot of money.

For better or worse I read all the reports. You never know when something insightful will turn up. But all to often they are masters of the obvious with a very limited ability to make you a lot of money. If the analysts and those darn price targets were always right we'd all be rich.

Disclosure: at the time of this posting the author was long LFC.