Iâm a big fan of Tom Brown with Second Curve Capital and have followed his work since he was a banking analyst with DLJ. He is writings are insightful and valuable in my opinion. So when I read his recent article entitled âThis Stock Could Nearly Double! â But Weâre Neutralâ discussing a recent sell-side analyst report covering Synovus Financial, it really struck a cord. I realize the irony of praising a former sell-side analyst in an article dismissing the work of these same analysts. This proves that there is at least some very competent analyst out there. Unfortunately, they eventually make it over to the buy-side.
For those of us in the investment business who have dealt directly with these analysts, I can personally say that they are generally bright, highly educated, hard working, and honest. So it has always struck me as odd that such an educated group can be so misguided when it comes to offering investment advice. This is an issue I have thought about a great deal. There are many theories about this ranging from things like âtheyâre all corruptâ to âtheyâre just plain stupidâ. I actually think this is an unfair assessment.
I simply believe that when educated in business school, they simply arenât taught how to make profitable investments. For starters, they are taught to treat the almighty quarterly earnings report as the gospel. The earnings model is a sacred tool where they can model out profits for years to come. I cannot tell you how strange it is to hear an analyst inquire to a companyâs management some of the following questions;
- âCan you tell me what your anticipated tax rate will be for the upcoming quarter?â
- âWhat will be your share count this year?â
These type of questions highlight a major blind spot for the analyst. They are far more concerned with next quarterâs results than finding profitable businesses. I can only imagine how frustrating it must be to get these questions. It is difficult to provide meaningful guidance on profit margins from quarter to quarter, yet this is what the expectation has become (I have also written about how meaningless it is to provide any short-term guidance).
Occasionally, one comes across a truly skilled analyst. One that understands the concept of buying a business rather than a trading piece of paper is a valuable source of information. Stay away from those that downgrade a stock three weeks after an upgrade just because the price appreciated.
Someone once gave me some simple but effective advice. He said âremember that everyone has a different objective when approaching the market (or investing)â. So when trying to interpret why someone is behaving the way they do â simply ignore and try to take advantage of the inefficiency.
