Investment Research
The Smart Profits Report: Issue #482
Wednesday, December 19, 2007
Investment Research: How To Avoid Getting Burned By The Analyst & Banker Tag-Team
By Marc Lichtenfeld
Senior Analyst, Mt. Vernon Research
It’s one of the biggest fudge jobs on Wall Street - and you owe it to yourself to know how the game is played, so you don’t become an innocent victim.
I’m talking about basic investment research. Most investors take it for granted and assume the source is credible and trustworthy, because of the big names involved.
But beware the tainted research. Over the past several months, I’ve had conversations with the research directors of several investment “boutiques.” These companies offer a wide variety of services, including investment banking, institutional trading, retail brokerage and investment research.
But it’s not as innocent as it seems. Let me explain…
Banking Drives Investment Research, So Be Careful Who You Listen To
From my conversations, one thing has become alarmingly clear: Despite the Securities and Exchange Commission’s best efforts, the supposed Chinese Wall between research and banking is about as strong as a tin shack in a hurricane.
I was told in no uncertain terms that banking drives investment research. Sure, while analysts are under no obligation to slap “Buy” ratings on stocks, the purpose of initiating coverage on a company is to drive banking revenue.
Think about that. Of course, one could argue that a research house would only want to do banking with a company that has good prospects in order to justify the buy ratings.
Yeah, right. If you believe that, I’ve got some swampland in Florida that I’d like to sell you (I’m serious. My house sits on a wetland preserve and is for sale. Plus, the Florida real estate market is dreadful. But that’s another column).
Let’s see how the game is played…
“Analyst” By Name… But Not Necessarily By Nature
Here’s what happens:
- The retail brokers at these investment research firms call their customers (you could be one of them) to tell them how much their sacred analysts like the stock.
- When Mr. and Mrs. Smith rush out to buy the stock on the brokers’ recommendation, liquidity increases and the stock is more attractive to institutional clients.
- Or, the institutions that may have provided funding to the company can now exit their position thanks to that increased liquidity.
Why so sneaky? One reason is that the business model of investment research has changed. Wall Street firms can no longer make a living simply selling research - hence the focus on investment banking.
Sure, big boys like Merrill Lynch (NYSE: MER) or Goldman Sachs (NYSE: GS) may still generate some revenue from institutions who want access to their investment research, but investment banking is what pays the bills at the large organizations, as well as the smaller outfits.
This doesn’t mean nobody challenges the way this business works. When the dot com sector blew up, there was considerable outrage that analysts didn’t always believe what they published and were simply selling out (to benefit both themselves and their firms).
But trying to get them to be a little more honest is a bit like trying to stop a runaway train. I’m confident that coverage of most stocks today continues to be based on current or potential banking fees.
The question is: Why should you care?
Beware The Investment Research & Banking Bias
Unless you’re getting investment research from a truly independent source - i.e. one with no banking or other financial interests - you could very well be reading a report that is biased due to conflicts of interest.
And if you act on that information… well, the last thing you want to do is base your investment decisions on research that was written not to educate readers about unique investment ideas, but to accommodate investment banking clients and their fat fees.
When I worked in the sell-side analyst world, I received my training from some of the best investment research guys in the business and worked for one of the truly independent firms.
After I left, I had several opportunities to return to the field. But the idea of letting my hard-earned skills whither and decay in order to shill for banking was not my idea of honorable.
Investment Research That’s Independent, Informative & Profitable
That’s why I enjoy writing for you here in the Smart Profits Report and for our premium content, the Xcelerated Profits Report. When I joined the team back in the summer, Investment Director Karim Rahemtulla gave me one simple missive: “Find the most profitable investments and information for our subscribers.” Period. End of discussion.
So next time you’re watching the business news, or reading a story online, keep this in mind: The analysts you see, or whose quotes you read may have the ability to stir the investment herd into a buying or selling action… but it doesn’t mean you have to listen to them. More often than not, it’s a knee-jerk reaction with a short-lived effect.
Bottom line: No matter where you get your investment research and information from, ensure that it’s truly independent and doesn’t use you to achieve financial goals for someone else. If it doesn’t make you money, or protect your wealth, be careful.
Hoping your longs go up and your shorts go down,
Marc Lichtenfeld
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Today’s Smart Profits Action Center
- It didn’t take Marc long to find the most profitable investments and information for our subscribers. Last Friday, he instructed Xcelerated Profits Report subscribers to sell half their position in the first company he recommended for a 99% gain. And in the January forecast issue, due out later this week, he gives his prediction for the five hottest biotech areas in 2008 - and the companies set to profit. Get more details here.
- One click to worry-free investment education. The “Information Age” has become so vast today that it’s often a minefield trying to separate the valuable information from the drivel. So give yourself a break and take a look through our extensive Smart Profits Report archives this holiday season. We’ve got no ulterior motives, we answer to nobody, and have filtered out the fluff. What’s more, our 2007 Archives are packed full of some of the best investment education you’ll find anywhere.
- One of the most reliable sources of information comes from watching insider buying trends. Nobody knows more about a company than its own executives and directors (certainly not analysts and media pundits), so pay close attention to what they’re doing. If they’re buying shares, it’s a strong sign of confidence, as they’re hardly likely to toss their money away on a losing stock. On the other hand, if insiders are bailing out of a stock for reasons other than planned sales or profit-taking, they could be fearful of bad news that the broader market doesn’t know about. You find a company’s insider buying information easily on its stock’s Yahoo! Finance page.
Related Articles:
- Contrarian Investing: The Best Investment Strategy You Should Use Today
- How To Effectively Handle Any Broker: Secrets to Getting Started In Options
- The Search for a Good Broker: Five Tip-Offs Your Broker’s A Fraud
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