Reply #1: WrapUp by Martin Goldberg [View All]

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The Problem With Wall Street Analyst Calls

Analyst upgrades and downgrades are usually based on predicted short-term business conditions. The analyst’s decision to upgrade or downgrade the stock is usually based on the current market value of the stock (typically assumed to be at “fair value”). The short-term business conditions cited by the analyst provide the basis to upgrade or downgrade the stock from its current “fair value”. In the case of the Merrill Lynch recent upgrade of the broad line retailers, the analyst is citing improved short-term business conditions that, when compared to slower conditions last year (but better conditions the year before), will appear as “growth” to the stock market. However, as any logical person can see, this is not growth. It is just a cyclical fluctuation in business conditions.

In any valuation model for shares in a business, the fluctuation in business conditions would only result in negligible changes in stock value. In spite of this, Wall Street uses these tactics to “job” the price of stock shares while increasing trading volumes. And yes, orchestrated short squeezes are also an integral component of many such analyst calls. Trading resulting from analyst calls supports the bottom line of the brokerages since their profits and revenue are directly linked to the trading volume supported by speculation. Hidden in this stock jobbing is the amount taken from the trading “gamblers” by the “House” via bid/ask spreads. In 1988 Warren Buffett estimated that these costs to traders amount to a sum equivalent to 8% of corporate profits.

A Solution

The Securities and Exchange Commission (SEC), who is charged with serving the public’s interest and is funded through tax dollars, could effectively end this useless and deceptive stock jobbing with practically the stroke of a pen. They could pass regulations that required all analyst reports, and stock upgrades and downgrades to contain a recognized long-term cash flow valuation model. One such model by Warren Buffett is described in, The Warren Buffett Way: Investment Strategies of the World's Greatest Investor, by Robert G. Hagstrom. The model would have to indicate all long-term assumptions along with predicted sales growth, margins, and other key fundamental data. Such rules would not entirely eliminate stock jobbing, but listing the analyst’s assumptions would provide traders and the public with a basis to evaluate whether their predictions were reasonable. In many cases, I’m sure that such predictions and assumptions will be exposed as obviously unreasonable or even absurd. Consider the string of crazy assumptions and predictions needed to justify a market capitalization of $20 billion for Amazon.com.

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Will Things Change?

Will things change in the near term? I don’t think so. The SEC is currently part of the problem and not part of the solution. Our political leadership feels that our overvalued stock market should be supported no matter what. They do not want to rock the boat for the public’s long-term good. They want us feeling rich and spending. Business as usual on Wall Street is part of that. Our economy is now too dependent on an undependable character – the stock market. The SEC makes us comfortable that the stock market is fair by parading Martha Stewart in front of the TV cameras every few days for several years. Then they rapidly settle with proven and admitted mutual fund thieves in a (figuratively) smoke-filled room behind closed doors.

Nothing has changed on Wall Street!