Monday, April 8, 1996

Have you ever tried to picture the people and faces behind the EPS estimates you dutifully type into your spreadsheets and PEG calculators? Obviously these analysts are of infinite and superior intelligence, are privy to special information, and are brimming with heaps of strong industry judgement and carefully thought out insights. Otherwise, they wouldn't be Wall St. analysts, right?

Earnings estimates are a uniquely gooroo-ish dance with many interesting incantations. Thinking about this led me to an active stock picking theory I call "Analysts Flying under Radar".

Some simple facts about analysts:

BIG-SHOT ANALYSTS COVER BIG-SHOT STOCKS.

Since most individual investors and company fund managers buy big stocks, the most experienced analysts at each firm are typically covering the "widely covered" stocks. This is a great deal for the "senior" analyst, since there are so many other analysts to fit your estimates between, and most large companies have very predictable growth patterns, which makes their predictions look good.

OPTIMISM KILLS.

When a company misses earnings, the single worst person to be is the analyst who guessed the highest. On Wall Street, "cautious early, cautious often" is the analyst's mantra. Nobody remembers the analyst that was well below estimates, but being well above will keep you off the ladder to bigger and higher paying coverage gigs.

YOU WATCH MY BACK. . .

It's in the best interest of a group of analysts to have a fairly tight range of estimates, making sure that if they're wrong, they're wrong as a group. This is good old fashioned "covering your butt," as American as apple pie. If the boss wants to know why you screwed up with your guess, you point to the analyst down the street who got it wrong as well.

FLYING UNDER RADAR.

So, extending the logic, the small, high-growth companies of tomorrow are largely being covered by "junior" analysts who are preservationists first (guess too low on purpose) and who, where possible, fit their guesses in between those of the other analysts. In other words, they fly under radar. What wide-eyed analyst would want to be set back two years on a career path for being duped into undue optimism on some tiny high-growth stock that NO-ONE else at their company particularly cares about, since the company money managers and buy lists stick to the big stocks? It's much easier to just blend in with your estimates and suck up to the bosses in other ways, and besides, it saves a ton of time on research!

Sort of explains why the best of these excellent little companies beat estimates quarter after quarter doesn't it?

The moral? Use this added leverage: buy great small-cap, high-growth companies and hold, hold, hold. The beauty in the model is the compounding underestimates quarter after quarter.

And send the analysts an Xmas card. Just sign it with a smiley ;-> They'll understand.

Transmitted: 4/8/96