Joshua Brown at The Reformed Broker has a great post up, Why They All Got the BP Call Wrong.
It’s about the folly of Wall Street analysts rushing in to call BP “cheap” and a “buy” so soon after the Deepwater Horizon blowup, even when the risks — legal, environmental and political — were off-the-charts bad and clearly unquantifiable.
Here’s the dagger (emphasis mine):
Rather than utilizing real-time data about buyers versus sellers in a particular issue, fundamental analysts concern themselves primarily with extrapolating the statements of perpetually lying executives and the endlessly manipulated earnings statements of the subject company.
Backward-looking results and metrics along with “color” from the latest conference appearance take the place of statistical realities on the ground and in The Tape. That’s why fundamental analysts can’t make you money consistently – because they are analyzing companies and not the stocks themselves. Oh, and they love “stories”. Just like my daughter at bedtime. It’s not their fault, their clients like stories, too. Can’t call up the portfolio manager at a pension fund and say the stock is going higher because it’s going higher, he’s got to know the reason.
Fundamental analysts don’t even pretend that they exist to make anyone money in stocks anymore. Look at the ratings they place on stocks these days, they’re absolutely incomprehensible! Overweight, underweight, accumulate, hold, focus list, attractive…seriously, attractive? Overweight? Thanks for that.
– Reformed Broker, Why They All Got the BP Call Wrong
Amen brother! In a previous piece, Oh-So-Predictable Analysts, I gave more color on what’s wrong with the sell side of Wall Street — namely that a self-serving institutional model leaves these guys hopelessly compromised.
A couple more reasons why Wall Street analysts fare so poorly:
- They don’t understand risk.
- They aren’t paid to be creative.
- Their narrow mandates are self-defeating.
First, on not understanding risk: The average analyst couldn’t trade his way out of a paper bag — if he could, would he still be an analyst? — and that means he (or she) knows next to nothing about risk control. These guys don’t know what it means to take on risk… to quantify risk… and, most importantly, to manage risk. It’s an utterly foreign subject to them.
If Wall Street analysts did truly understand risk, they would look at the risk factors inherent in the companies they shill for in a whole new light. But then, too, the institutional nature of the job prevents the analyst from honestly assessing risk in the first place.
Second, on not being paid for creativity: I have both friends and relatives (including an immediate family member) in the investment banking business. I have heard, on multiple occasions with free-flowing alcohol present, what it is really like inside the money changer’s temple.
These firsthand accounts dovetail with what Jonathan Knee described in The Accidental Investment Banker: To climb the ladder, you must be part gopher, part robotic drone, and part excel-sheet monkey… and you must be willing to drown yourself in brain-numbingly mundane tasks, 70 hours a week, year in and year out, until you finally crawl from the trenches with your pound of financial flesh. Not exactly the province of fresh and original thinking, eh?
It is thus no surprise that there are precious few pockets of creativity in an investment bank — the ones that exist all too often residing in the accounting department. Creativity takes a distant backseat to conformity, galley slave work ethic, and not rocking the boat. This means that analysts — who all came from the same schools, as Joshua Brown points out — tend to think, act, and reason all alike. They are like an army of clones. This dramatically reduces their ability to spot danger, ferret out profitable anomalies, or otherwise be of any real use in a deeply competitive environment where following the herd is a recipe for losing money.
Third, on the self-defeating nature of narrow mandates: Half the beauty of being a trader, or a sufficiently flexible investor for that matter, is that you can go where the opportunity is. You aren’t limited to looking at just utility stocks, or just oil service names, or what have you. You can scan the broad market for the most attractive risk-adjusted opportunity set, long or short, at any given time. And of course, if you’re comfortable with global macro, your palette is even wider.
Now contrast that range of movement with the poor sell side analyst who often not only has to stick with the same industries… he (or she) has to stick with the same damn do-nothing stocks! If you cover IBM, and your boss is expecting comprehensive report coverage of IBM, that means you have to come up with all kinds of pointless shit on a deadline — IBM blah blah this and IBM blah blah that — even when an honest assessment would run something more like this:
“You know, there’s just not a lot going on here right now… reward to risk is muddled… IBM looks fairly valued and dull as dishwater, with potential to drift slightly up or down based on god knows what… if it were up to me I’d be looking somewhere else.”
An analyst could NEVER write something like that, oh no. Instead they have to pull out the jeweler’s loop and examine all kinds of cockamamie minutia, and proceed to crunch numbers with a degree of false precision that adds about as much value as trying to count the leaves in Central Park.
There is some good news though. You and I get to trade against these guys — or rather, the poor sod investors who still take their stuff seriously.