TCS Daily


Don't Blame Analysts

By James K. Glassman - March 27, 2002 12:00 AM

Every bear market breeds scapegoats. This time around, politicians are pointing at stock analysts. Their particular crime was the failure to predict that high-tech shares -- and especially Enron shares -- would tumble. The reason for the failure, we're told, is conflict of interest.

As employees of large Wall Street firms, analysts are said to favor companies that send investment-banking business to the other side of the Chinese Wall. But conflicts of interest are a part of life. The question is whether analysts -- like, for example, journalists surmounting their own political biases -- can overcome conflicts and offer good advice. Most do. After all, there's nowhere to hide. Analysts' picks are closely examined by investors, money managers and trade publications that compile influential ''all-star teams'' of the best in the business.

The game is simple: pick winners. An analyst who doesn't is ignored or fired. Sure, there are abuses. Some unscrupulous firms have canned analysts who criticize clients. But word of such chicanery spreads, and the firm's reputation suffers.

How good are analysts? Forget the anecdotes and look at the research. Brad Barber of the University of California at Davis and four colleagues last year published an academic paper in the Journal of Finance that examined 360,000 pieces of advice from 269 brokerage firms and 4,340 analysts between 1986 and 1996. They found the analysts' top-rated stocks beat the market benchmark by an average of 4.1 percentage points, and their lowest-rated stocks trailed the market by 4.9 points. That's spectacularly good performance.

Certainly, some analysts -- because of conflicts or plain stupidity -- make mistakes. But Enron is a mighty slim reed on which to lean a heavy new regulatory regime. Enron's executives and auditors willfully misled investors; they destroyed documents; they hid their liabilities where no one could find them. No wonder analysts were taken in. Who wasn't? Fortune magazine named Enron the ''Most Innovative Company in America'' and tops for ''Quality of Management.'' Mutual-fund houses such as Fidelity and Janus, which use independent analysts, owned huge chunks of Enron stock. The impeccable Value Line Investment Survey, with no investment-banking conflicts, was still recommending Enron enthusiastically in October.

Politicians themselves are misleading investors by blaming analysts for stock losses. What investors need to recognize is that stocks go down as well as up and that calamities happen to companies. It's cruel to send the signal to investors that they don't have to worry, Big Brother will always protect them. In fact, the best protection is taking personal responsibility: Don't accept any analyst's judgment as gospel, buy companies with great long-term track records and diversify like crazy.

A version of this article first appeared in USA Today.
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