As a recovering analyst of 20 years, and a repeat member of The Wall Street Journal's Best-on-the-Street All Star Research Team, I look back on my experience with decidedly mixed emotions. In hindsight, securities analysis is a delicate blend of tightrope-walking, literary quick-change acts, educated guessing, inappropriate compensation, intermittent boredom, and stark terror.
I entered the securities industry straight out of college as a trader in New York City, and it proved an ideal place to learn the inside workings of the market. But after earning a couple of graduate degrees, and with a penchant for both writing and numbers, I seemed more properly suited for research.
As Fools undoubtedly know, analysts typically specialize in a single industry. In my years as an analyst, I focused in turn on energy -- primarily service companies such as Baker Hughes
In recent years, notorious figures such as Salomon Smith Barney's erstwhile telecom analyst Jack Grubman, and Morgan Stanley Dean Witter's Internet doyenne Mary Meeker have shaped analysts' image in investors' minds. Wall Street Journal reporter Monica Langley's Tearing Down the Walls, a biography of Citigroup's former CEO Sandy Weill, describes Grubman's pervasiveness and his sky-high compensation:
"Grubman had a knack for using colorful language rather than the dry verbiage of most stock analysis ... (He) was featured on magazine covers and was constantly being interviewed by the business press, both print and television. Goldman Sachs had tried to lure Grubman away from Salomon Smith Barney, but his fawning bosses persuaded Grubman to stay with the promise of $20 million a year...."
Grubman ultimately played a big role in shaping the popular image of analysts as hustlers, more interested in luring business to their firms than conducting carefully reasoned, unbiased securities analysis for clients. Self-serving approaches like his awakened New York's Attorney General Eliot Spitzer, leading to the $1 billion fine collectively paid by 10 securities firms. That investigation also spurred the overhaul of the street's research, stock allotment, and investment banking practices.
A feast of regulation
Overhauls are generally applauded, especially when they correct ethical lapses. Clearly, the practices of securities analysis needed an upgrade. But I believe that the Spitzer overhauls did more to hinder honest analysts than rein in miscreants.
In concert with a 2000 Securities and Exchange Commission ruling known as Regulation Fair Disclosure, or Reg FD, the Spitzer reforms have made analysts' world a tough slog. In essence, Reg FD says that companies shouldn't provide information to a single analyst that they're not willing to simultaneously share with the entire world.
In my experience, Reg FD has been more effective in keeping analysts and companies at arm's length from each other. That distance keeps analysts from getting the kind of valuable, detailed information they can eventually pass on to investors. Instead, corporate disclosure now seems to emerge in clumps, often leading to herky-jerky movements in companies' share prices.
More importantly, as an analyst, I was once able to submit earnings models -- my relative guesses at future income statements -- to companies for guidance, enlisting their help in ensuring I'd gotten the details right. Reg FD now forbids discussing such models before their publication. Instead of individual discussions between analysts and companies, we get publicized financial guidance, which has plentiful weaknesses of its own. Managers often shoot low with guidance, then congratulate themselves when the real numbers exceed their own sandbagged estimates.
The quarterly ritual
As if this ridiculous guidance dance weren't bad enough, quarterly earnings releases have become their own sort of ritualized comedy. Companies now release guidance long in advance, and analysts base their estimates on that guidance -- no working without a net for this crew. When earnings are released, the company conducts a carefully orchestrated conference call, beginning with an absurd and lengthy safe harbor statement. This vestige of 1995's Securities Litigation Reform Act leaves managers droning on, often for minutes on end, about how their company's future isn't entirely certain. (No, really?)
After managers have repeated the same information included in the earnings release, a parade of preening analysts poses often frivolous questions. Once the company's numbers have been picked to the bones, the call is ended, and the analysts scramble to craft their comments. Those opinions are generally based on whether the company met its (self-imposed) guidance, or on the future predictions the company has newly issued for itself.
If these factors compel an analysts to change their ratings on a company, they'll usually couch their rationale in regal first-person doublespeak, complete with the royal "we": "Given our concern about impending events at the company, and in view of the lack of opaqueness for future periods, we are raising our rating on Widget Technologies to a short-term hold, and a long-term buy, with a heightened medium-term confidence rating..."
It's enough to make any Foolish investor's head spin. Reg FD addressed a very real problem, but I'm beginning to wonder whether the cure we got was any better than the disease. Come back tomorrow, Fools, for even more insights from the strange world of securities analysis.
For related Foolishness:
- Analysts Running Scared
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- Thomas Weisel: Loaded on Tech
- The Wall Street Guarantee
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Fool contributor David Lee Smith does not own shares in any of the companies mentioned. He welcomes your comments or questions. The Fool's disclosure policy is always on the level.
