Should Fools Care What Analysts Think?
by NCN Bolt

One of the dichotomies in Fooldom that amuses me is the perception and treatment of sell-side analysts. There are frequent calls for better analyst accountability, occasional accusations of outright dimwittedness, and periodic praise for these well-paid Wall Streeters. I'd say all these reactions are appropriate at times. However, I suggest that there is a less chaotic way to approach all Wall Street research, so that you aren't blaspheming one analyst and lauding another. Simply put, it's one more place to learn about potential investments.

Without question, demands for accountability are appropriate. The ruminations of the Wise carry few quantitative measures of prior success. Unlike the Fool Portfolio, we know little about the past record of an analyst. Has that person identified stocks that increased in value, or has he simply been a mouthpiece for his firm's underwriting efforts? Wall Street works diligently to obscure any answer to these questions. A Foolish consumer of Wall Street research needs something more concrete that the fawning prose that fills reports on various analyst All-Star teams.

On the other hand, what good comes from the allegations of stupidity, idiocy, or blindness that are hurled at certain analysts, particularly those who view popular stocks such as Iomega as a short sale. These epithets seem a bit of a stretch given the formidable grey matter possessed by some analysts. I'm tempted to make the argument that analysts are kindred spirits in the investment world, working hard to make some sense of the future prospects of the 12,000 public companies out there, just like we are. But that really holds no water, either. These folks are paid for a raft of activities that have nothing to do with selecting good stocks. This means their goals are not always in line with those of the individual investor, but it does not mean that they are lower case "fools."

Lastly, I've noticed comments that praise analysts. They well should, when an analyst is a competent champion of great performing stock. However, many analysts have more buy recommendations than I do digits. Tout enough stocks and you always have a winner. In my opinion, analysts deserve praise when they add more to the analytical process than simply reprinting quarterly earnings releases on fancier paper than the subject company can afford. The analyst who travels to the ends of the earth to better understand some mine or power project, and then makes me understand what implications the asset has for future earnings, has helped me. The analyst who spends years getting acquainted with an industry, and who makes some substantive commentary on competitive issues, thorny accounting, or shifting demand has me as a fan. Praise of analysts should reflect the quality of the analyses they perform. After all, the title "analyst" assumes the ability to analyze.

I submit that we should treat sell side analysts with the same pragmatic point of view that we give to all other sources of information. In response to the anxious broker who wants us to consider his firm's research as a reason for paying the big bucks to trade at full commissions, we should:

1) Ignore the heck out of them if we're using Beat the Dow, Investing For Growth, or any of the other mechanical models. Life's too short for research we'll never need or use.

2) Use Wall Street research only as an adjunct to the whole fundamental investing process. There's no sin in looking over the work of an occasional analyst, but we should realize we don't need them to succeed. Buying a stock on an analyst's recommendation seems to miss the whole empowerment theme of Foolishness. If we're using the PEG ratio to value stocks, we must realize that part of that equation is based on analyst's expected earnings. If you think the analyst's estimates on a particular stock are miles from reality, beware the PEG you derive.

3) Take advantage of bad information. One of the magical quirks of Wall Street is that despite more graduate degrees per square foot than your average postal code, these guys make some honking big errors. Don't be bitter at analysts who draw substantially different conclusions about a stock than you do. I like nothing better than a guy out there trying to poke holes in a stock that I like. Why not see the negative case on a stock? It lets us test our case for owning it.

Analyst bashing is a lot of fun, but there are ways for individual investors to profit from Wall Street's prodigious output. Do so!

[Editor's Note: NCN Bolt is Carter Newbold, a guy with a wife, dog, house, and a pretty good life in Charlotte, NC. He sheepishly admits to working as a portfolio manager, but doesn't want to talk about how his portfolio stacks up against The Motley Fool's results.]