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No Easy Way to Track Stock Advice

Sat Aug 7, 2004
By Ritu Kalra

NEW YORK (Reuters) - In Wall Street's brave new world of stock research, there's no standardized way to track performance.

For investors seeking guidance on whose stock picks to follow, this means the going can get rough.

Consider: Ten Wall Street powerhouses rolled out new research offerings last week, giving clients -- for the first time -- a second opinion on the stocks their brokers cover.

The new reports, mandated by the $1.4 billion settlement with securities regulators over biased research, offer a refreshing perspective.

But this bounty also makes it more important than ever for investors to read the stock research reports carefully before they reach for their wallets.

Research departments at both independent companies and Wall Street firms have different criteria for their ratings, and those that track analysts' performance use different techniques as well as different data, which can sometimes lead to contradictory results.

"There are seven different approaches in the marketplace to calculate performance," said Michael Mayhew, chief executive of Integrity Research Associates, a consulting firm based in Darien, Connecticut. "All of them are different. You don't think that's going to cause confusion?"

A STAR FOR ACCURACY

For those seeking the best analyst within a particular sector, StarMine, a performance tracker based in San Francisco, offers one approach. It ranks analysts relative to the industry they cover, giving top marks to those with the most accurate earnings estimates. The service is free for retail investors, but they can only see the top-rated analysts -- and whether or not their stock picks would have made them money is a secondary consideration.

"Analysts, by and large, are not employed to call the market," said David Lichtblau, vice president of StarMine. "They're paid to say which companies are going to perform better than others."

Individual investors, however, may have different priorities.

"Why does an individual investor care which oil analyst is better than the next?" asked Alexander Paris Jr., director of research at Barrington Research Associates, who uses the Starmine system to evaluate his own analysts. "Relative performance doesn't put dinner on the table. If you lose less than the next guy, that doesn't help you a lot."
SHOW ME THE MONEY

Investars, a performance tracker based in Hoboken, New Jersey, gives investors another yardstick. The company creates a hypothetical portfolio that rewards or penalizes research ratings, based on movements in the company's stock price.

For about $20 a month, investors can look up the best -- and the worst -- performers by stock or sector.

For retail investors, that's intuitively appealing.

"Individual investors want to make more money in the good times, and they don't want to lose a nickel in the down times," said Barrington's Paris.

Looking at the performance numbers also can help investors avoid the worst analysts.

"If you hired an architect, you'd probably want to know how many of the houses he built previously collapsed on people's heads," said Kei Kianpoor, Investars' chief executive. "It's absolutely important that there's transparency in the process."

But academics warn that Investars' analysis may be too simplistic. Small-cap stocks, for example, have been on a winning streak for the last five years, giving the research firms that focus on them an inherent lead.

"That's not because of any individual stock picks, but because the particular universe happened to be in favor at the time," said Brett Trueman, a UCLA accounting professor who recently co-authored a study on research performance. If the flavor of the day happens to change, Trueman said, investors could be left chasing a losing recommendation.

A 'BUY' BY ANY OTHER NAME

Complicating matters further is the fact that firms mean different things when they assign a rating to a company.

Morgan Stanley(MWD.N: Quote, Profile, Research) , for example, has a three-tiered system that rates a company based on its expected performance relative to its industry, overlaid with a measurement of the stock's expected volatility. On this basis, it ranks computer maker Dell Inc. (DELL.O: Quote, Profile, Research) an "overweight," with a $42 price target -- above Dell's close on Nasdaq at $34.78 on Thursday.
But the information technology sector Dell belongs to carries an "underweight," which means Morgan Stanley expects Dell to outperform in an underperforming industry -- a nuance that can easily be missed.

The new independent research available to investors adds yet another layer of complexity. Dell is rated a "buy" by K.L.D. Research & Analytics, Inc., an independent firm whose research is distributed through the BNY Jaywalk system, a unit of The Bank of New York Co. Inc.(BK.N: Quote, Profile, Research)

Along with a snapshot of how its ratings have historically stacked up against the company's stock price, the report's first page explains the basis of its recommendation: not on conventional financial analysis, but on social and environmental benchmarks instead.

That makes applying a single standard to measure performance incredibly difficult -- and no substitute for actually reading the content of the research report.

"Ratings don't tell you how much to buy," said UCLA's Trueman. "For someone who already has a large position, the caveats (in the report) could mean you should actually reduce your position."

Then again, Trueman is all for tracking performance.

"The more information that individual investors get, the better off they are," he said, adding his own caveat -- as long as they understand the context and limitations of the numbers.

 

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