How to rate an analyst

From Star Online: Business

15th June 2013

WHO do you turn to when you need advice on stocks? A broker or remisier will be the obvious choice but they too get their information from a bunch of number crunchers whose job is to analyse stocks.

They are an important cog in the investment chain, often reviewing results, visiting companies, and writing their analyses of the companies under their coverage. The summary of their research culminates in a recommendation which is either to buy, hold or sell the stock.

Listed companies know just how important they are. Whether it’s a company going for a listing, announcing its new earnings stream or when a stock is to be placed out, analysts are sought to come up with a handle on what the companies are doing and what they hope to achieve.

So should we listen to analyst recommendations? How accurate are they, and do they really have retail investor’s interest at heart?

 

Market movers

Whatever people may say, analysts’ recommendations do dictate the movement of markets. We know a “sell” call byCIMB Research or the foreign brokers such as Credit Suisseor Macquarie can be catastrophic to a company’s share price and lead to huge selling pressure.

After all, the big brokers are the ones with the large institutional following.

When analysts churn out a “buy” call on a big cap stock for instance, there are a myriad of reasons at play here.

Is it mainly to please their clients on the buy side or their institutional clients?

The buy-side folks could possibly be piling on the pressure for the analyst to come out with a good quality report on the company. If the analyst refuses too, could this mean lesser trading volumes and revenues for the company?

Most fund managers and analysts contacted were in agreement that a “buy” call by an investment bank-backed analyst had a tendency to be biased, as there were times this was to faciliate a deal or please certain powers that be.

“Analysts are also people doing sales. Their product is the stock. They are driven to please their buy-side clients and maintain a good relationship with the management of the companies they cover,” says one fund manager.

“Independence differs from one firm to another but in CIMB, our aim is to be as objective and independent as possible as our job is to make money for clients so our credibility is always on the line,” says Terence Wong, CIMB head of Research.

He adds: “We are an institutional research outfit so our clients are institutional too.”

Relationships and connections

There is the other issue of maintaining a good relationship with management of the company.

Relationships are important anywhere in the world, but more so, in connection-based Kuala Lumpur, remarks one head of equity capital markets (ECM).

An unnamed research head cites an example of how it can be sometimes difficult to call a “sell” on a company, especially when the CEO or MD is a well known tycoon.

“You call a sell on their company and somehow, the relationship turns sour after that,” says the analyst.

He says that accuracy in stock selection and earnings forecast are important, but how does one measure that?

“First of all, the timeline of measuring the stock’s performance may be too short. The analyst may have changed the call halfway,” he says.

When an unknown analyst suddenly writes a bullish report on a lesser known company, how many investors actually ask about the analyst’s track record?

“If he’s giving a target price that is 100% higher than the stock’s current trading price, isn’t it reasonable to want to know how well this analyst’s past calls have been?” says the ECM Head.

He adds that what the institutional clients want are analysts who have quality of ideas and strength of analysis in their reports.

“I think they treasure contrarion ideas. Not analysts who just go round parroting what others say. A lot of analysts do that,” says this research head.

He notes that an analyst’s access to management of a company, and his “connections” were extremely important to buy side and institutional clients.

“Of course an analyst who can provide company visits, arrange meetings with the management and provide smoothness of dealings will be ranked higher. If the brokerage organises more conferences, then that also becomes more important,” says the research head.

He says that one important thing that needs to be evaluated was the trustworthiness of an analyst.

“Sometimes we do wonder why an analyst calls a buy on a stock. Is it deal-driven? It’s not easy issuing sell calls. I have had my share of backlashes too. So you have to read between the lines when an analyst downgrades a stock from a buy to a neutral. You also need to look at the timeline of the recommendation. Is it short term, medium term or long term,” he says.

When rating an analyst, Aberdeen Asset Management Sdn Bhd managing director Gerald Ambrose looks at enthusiasm, ideas, inquisitiveness and the analyst’s willingness to look at a company afresh, irrespective of what others say.

Qualities to look out for

“It’s important for the analyst to look closely at the company’s annual report – related party transactions, issues of governance, breakdown of debt, and decide for himself whether he likes a company. We look at their spreadsheet work and whether they do their homework on the companies. The kind of ideas they generate.

“Most broker research is inevitably commercial and is therefore short and to the point. That does not necessarily work for us. If there is one thing that analysts could improve on, perhaps it could be thoroughness of their reports,” says Ambrose.

For the broking houses, Ambrose says that the company used to have a system where it rates all broking houses worldwide based on their ability to access the senior management of a company they covered.

“However we are now instigating a more comprehensive look at many factors. For example trade execution, the accuracy, timeliness of settlement and reporting, setting up the meetings, that sort of thing,” he points out.

Areca Capital chief executive officer Danny Wong feels that an analyst should be rated independent of the brokerage, or the trading commissions he generates.

“We do look at their track record, for example the assumption of their earnings and transparency in the way they write their reports.

“We like an analyst who does his homework, and not just follow the numbers blindly. He must be transparent in the sense that he writes his report and discloses the basis or formula for his earnings growth or certain assumptions.

“Detail is very important. We like an analyst who does follow-ups and reviews on stocks. Or if this analyst visits the company even before an event has taken place, because he thinks something is up,” says Wong.

On the rating of brokers, the research head adds that the glamourous Asiamoney broker ranking sorts do not provide a real assessment on an analysts’ skills.

“It’s a fact that the houses with the most deals will win these glamourous awards. What we do value are the clients internal voting system.

“This broker tiering is important, and to a certain extent will dictate the number of sales that come into a brokerage,” says the research head.

[Source]