Analysts Miss the Big Picture[Fool on the Hill] April 5, 2000

An Investment Opinion

Analysts Miss the Big Picture

By Brian Lund (TMF Tardior)
April 5, 2000

It has come to my attention that a lot of people feel that the Fool mistreats the Wise. We seem to give them no respect. We question their motives, doubt their forthrightness, and freely mock their unhelpful cliches.

I'm here to tell you that this Fool, at least, doesn't think that the Wise are totally useless. I may question, doubt, and mock them, but I recognize that there are a lot of very smart people in their number. Many of them, furthermore, know much more about securities analysis than I ever will. When I read an analyst's report on a given company, I regularly come away very impressed by the level of her insight and depth of knowledge.

That's why it's so tragic to see the Wise go astray at the last moment. Their analysis may be insightful, but their vision seems to reach its outermost limit at the next fiscal year, and more often than not can't escape the current quarter.

Let me give you an example. A couple of weeks ago, as some of you who follow the Rule Breaker may recall, the Market laid a beating on biotech behemoth Amgen (NYSE: AMGN). One of the forces that motivated Amgen's descent was a downgrade from Merrill Lynch. On Thursday, Merrill lowered its long-term rating on Amgen from "Buy" to "Accumulate." To give the rating a little context, it is the same as Merrill's long-term rating for CKE Restaurants (NYSE: CKR), which we covered in the Fool News today. Is Merrill actually telling clients that Amgen and CKE have similar prospects?

Note that this change applied to the long-term rating. The "near-term" rating, as Merrill calls it, stayed at "Accumulate," where it has been since a similarly significant downgrade in August. I won't mention the fact that Amgen has been up for all but about 6 days since Merrill issued the near-term downgrade, and now stands over 40% higher than it did on that fine summer day, even after the Recent Unpleasantness. I also won't point out that this performance is way better than the S&P 500 over that time. These facts I pass over in silence.

Why did Merrill's very precisely articulated position on Amgen change? According to the research comment, it was because the litigation brought by Amgen against Transkaryotic Therapies (Nasdaq: TKTX) for patent infringement on the blockbuster drug Epogen was to resume on March 27. Merrill says that the trial, the outcome of which they are not willing to predict, is likely to cause extreme volatility "over the next few months until Judge Young hands down his final ruling."

Merrill issued a long-term downgrade now because a trial that we've known about for, well, a long time started the following Monday? In fact, in a similar research comment in December, Merrill noted that the judge had refused to decide the case summarily and that the hearing would begin in January. They did not lower their recommendation then, however. I suppose that would have been too long-term.

Perhaps Merrill anticipated a settlement or summary decision. Perhaps they didn't want to make their momentous decision to downgrade until they knew for sure there would be a trial. Perhaps, though they don't mention it until the final paragraph of the comment, their opinion has changed now because Amgen's current valuation is higher (well, was higher a few weeks ago, anyway) than it was in January.

My point is that, despite a very good understanding of Amgen, Merrill's conclusion doesn't make sense. First, the patent dispute is a peripheral matter for a long-term investor. That is not to say that the case isn't significant. It is. Epogen is Amgen's biggest product. It was responsible for half of Amgen's revenue in 1999, and it's expected to produce $2 billion in sales this year. Enforcement of Epogen's patent is an important matter.

Still, it's not the totality of Amgen's business. The patent on Epogen will expire in 2005, with or without this trial. Competition with Transkaryotic Therapies (TKT) wouldn't start until 2001 in any case, so Amgen still has time to profit from exclusivity. Even if the judge finds for TKT, Amgen will probably still control most of the market for the drug, albeit presumably at a reduced price. Finally, Amgen has its next-generation variation of Epogen, Novel erythropoesis stimulating protein (NESP), in Phase III trials right now. With luck, NESP may appear on the market in the next few years.

Second, Merrill is reacting only to the possibility of difficulties at Amgen. Nothing certain has happened to change Amgen's long- or even near-term outlook. It is the same business that it was January 26, when Merrill advised its long-term clients to buy Amgen. By letting only the potentiality of a problem grow in importance to make them reevaluate their position, based on no actual change in conditions, Merrill is allowing fear and uncertainty to drive its recommendations.

I mean, how can Merrill actually assert that short-term volatility is a legitimate reason for reconsidering its long-term rating on a stock? What difference does it make if it goes up and down in the next few months? How does that have anything but a psychological effect on investors? Since nothing fundamental has changed, Amgen is just as worthy of a long-term "buy" today as it was three weeks ago. In fact, the savvy investor can take advantage of these temporary tribulations by buying at abnormally low prices. In that sense, I'd say that the trial is making Amgen even more of a "buy" than it was before.

And here's the punch line: the research commentary that contained the downgrade was entitled "The Big Picture."

A title as ironic as that I could not have concocted. Yet I'll wager that the analyst who wrote it really thought that this was the Big Picture -- I mean, they were looking at more than a quarter's worth of uncertainty. Doesn't get much bigger than that, does it?

Now, if you want to read a good Big Picture piece of analysis on Amgen, check out Zeke Ashton's Foolish research report! And if you've been meaning to invest but haven't found the right broker, check out the Fool's new and improved discount brokerage center!

Fool on!

-- Brian Lund, TMF Tardior on the boards