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Why Your Favorite Stock Analyst Only Has Good News

Jun 11, 1998 | ZD Net

Investors digest a daily slew of upgrades and downgrades from Wall Street analysts, but are far from getting a balanced diet mostly good news with a dash of positive spin.
So where's the bad news?

According to Chuck Hill, director of research for First Call in Boston, two-thirds of the analysts have buy ratings on the stocks they cover with 1/3 having a hold. Less than 1% tell investors to sell.

"Analysts bring an inherent optimism to the table," said Hill. "They try to be objective, but have rose-colored glasses." But those rosy outlooks also mean investors get bad news too late.

Maureen McNichols and Patricia O'Brien, professors of accounting at Stanford University and York University in Toronto, respectively, found in a December 1996 study that analysts drag their feet when it comes to reporting negative.

"After surveying analysts' recommendations over a number of months, it became apparent that they delayed negative revisions to their estimates," McNichols said. "What it boiled down to was people were afraid or unwilling to be the first ones to say, 'Hey, there's something wrong here.'"

Andrea Williams, an analyst at Volpe Brown Whelan & Co., went out on a limb in December when she cut her rating on Yahoo! Inc. from a buy to a neutral rating. Figuring the young company's relatively small earnings potential would stymie any prolonged appreciation, Williams figured it was time for Yahoo! to cool. Instead, it went to 129 5/8 by April.

"Yeah, I was little off on that one," she said. "But at the time, it seemed like a safe move. Who could have predicted the performance of these Internet stocks?"

The good news bias arises because analysts serve many masters. Often the analyst covering a stock works for a firm that funded the initial public offering or plans to assist in a secondary offering.

Analysts also have to maintain a working relationship with the companies they cover. Criticism can strain the relationship, leaving the analyst out of the information loop. Finally, analysts have to look out for their clients, a long list that includes everyone from money managers to your aunt.

That juggling act can leave some analysts sounding like a corporate mouthpiece, but the good ones maintain objectivity.

"It can be tricky at times, but it's my job to put aside everything else and concentrate on providing the most value to my clients," said Louis Mazzucchelli, an analyst at Gerard Klauer Mattison. "It takes a lot of confidence to be the first to make a move especially a negative one but that's what we're paid to do."

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