Tired of Stock Answers? (2024)

Watching the whole spectacle are open-mouthed individual investors, clutching their wallets, with one question in common: Now where do we turn for research?

A once-obscure source is becoming more accessible. Goldman Sachs Group Inc. may have gotten Enron wrong. So did J.P. Morgan Chase, Credit Suisse First Boston, Deutsche Bank and a fistful of other brand-name Wall Street houses. But a few no-name, never-heard-of-'em, independent research companies got it right.

Computrade Systems Inc. and Alpha Equity Research Inc. urged investors to sell Enron around this time last year, when its shares still hovered in the $50-to-$60 range, well below their $90 high but miles above the pennies they trade for today. Callard Asset Management told investors to sell on Aug. 14, the day the stock closed at $42.11 and one day before Goldman Sachs said buy.

Alpha, Callard and Computrade are only three of about 120 small independents that follow public companies, crunching the numbers, each following its own complex proprietary computer model. Most small investors have heard of Bank of America and Salomon Smith Barney. It's doubtful they know Channel Trends Inc. and Market Profile Theorems. Or Beacon Street Research. Or M Capital Research. Nor would most individual investors want to get too chummy with "money-flow research" or "forensic accounting data converted into quantitative indicators," the kinds of technical facts the research firms parse.

But the investors might like the results.

In an admittedly unlikely scenario, an individual who invested in the 42 stocks followed by Avalon Research Group might have earned a 49.97 percent return for the year ended Friday. A portfolio of the 115 stocks followed by Sandler O'Neill might have racked up a 27.81 percent return on investment. Both of those in a year that's been notably, well, problematic.

Those figures come from Investars.com, a recently launched Web site that rates the performance of various research firms by compiling a theoretical portfolio for each company based on the stocks it follows, and trades the shares in the portfolio following the company's recommendations.

Opening Up

The independent research firms aren't new. What's new is that they're starting -- being prodded, in some cases -- to be more available to the individual investor. Instead of signing up pension funds and institutional money managers at $20,000 or even $60,000 a year, they're offering reports on individual companies for anywhere from $10 to $300 each.

In fact, the Bank of New York, one of the nation's largest financial services firms, last month inked a deal to buy Jaywalkinc.com, a site that aggregates and ranks reports from independent research firms. The bank plans to make Jaywalk's information available to its brokerage clients. A handful of independents, as well as some majors, also make their reports available on Yahoo Finance (finance.yahoo.com). Reports by independent research providers (as well as brokerage houses and investment bankers) are also featured on the MultexInvestor.com site. First Call/Thomson Financial (www.thomsonfn.com) abstracts research, as does Starmine (www.starmine.com).

John Meserve, president of Westminster Research Associates, the Bank of New York subsidiary that acquired Jaywalk, said one of the main reasons for the buy is a big post-Enron, post-Internet-bubble uptick in demand for research free of any possible conflicts of interest.

"The buzzwords I keep hearing from clients are 'primary sources,' " Meserve said. That means research relying exclusively on official documents, rather than on information gleaned from corporate executives. "People are looking for more independent ideas," he said.

Currently, Jaywalk includes research reports from 15 independent firms. More may be added. The site does not list research reports from concerns that do investment-banking work for the companies their analysts cover.

A Different Approach

Research into corporations follows most of the same broad lines no matter who is doing it. Analysts look at the climate of the market, of the sector, then the company. They look at the company's price and earnings targets; they judge its ability to generate those earnings. In their reports they explain the company's structure and whether it's appropriate to the kind of business the company is trying to do. They construct complex mathematical models using company-provided numbers and try to project where the firm is going.

Where they may diverge is in the modeling, in which numbers they emphasize -- and what they believe about what they're told.

There may be another difference, though. Officials at the independent research providers say they sometimes succeed where Wall Street fails because they rely exclusively on publicly available documents and their own computer models to predict performance.

And, unlike analysts at the big Wall Street houses, professionals at these research-only firms say they studiously avoid contact with executives at the companies they cover. They don't do on-site tours. They don't schmooze with corporate execs or join them for golf. And they do not believe this lack of access damages their ability to offer reasoned opinion on whether stock in a company is likely to rise or fall.

"We don't listen to the pitches, and we don't fall in love with ideas or managers. It's very much by-the-numbers," said Ricardo Bekin, chief investment adviser at Chicago-based Callard, which also issued a sell rating on Global Crossing on Aug. 13. The telecommunications firm filed for bankruptcy protection on Jan. 28.

Crunching Numbers

In contrast to the diversified firms that do both investment banking and stock research, the firms that Jaywalk monitors generally concentrate exclusively on research and perform no banking services. One exception is Callard, which was once a research-only concern but now also has a "buy-side" asset-management arm that uses the firm's research to invest in securities for individuals and institutions.

Of course, just because this research is "independent" does not guarantee it is more accurate or better informed than the research flowing out of Wall Street. In fact, Bekin said his firm had no great insight that anything in particular was wrong at either Enron or Global Crossing but that "when we crunched the numbers, the value just wasn't there."

Jaywalk/Bank of New York recently ranked analysts on how closely they predicted the performance of the stocks making up the Dow Jones industrials for the year ended Friday, collecting data on 116 Wall Street firms and 15 independent analysts. The independents don't always come out on top; indeed, there are some stocks that none of them track. But John Eagleton, president of Investars, points out that 24 of the top 90 spots -- Nos. 1, 2 and 3 in calling a stock's performance -- were taken by independent firms when average return is calculated. Looking at cumulative return, the independents fill 49 of the 90 spots.

According to the Jaywalk chart, a GM stockholder following the recommendations of Bank of America last year would have earned a 31.87 percent average return on his money; following Callard would have brought a 26.65 percent average return; Fahnestock's calls would have meant an average 25.43 percent return. Callard beat Merrill Lynch and UBS Warburg on Alcoa's performance. Callard, Alpha Equity and Computrade beat all the analysts on Hewlett-Packard.

Tim Alward, president of San Diego-based Ford Investor Services Inc., said the reliance on number-crunching free of boardroom spin was the key advantage enjoyed by independent research firms.

"When you are talking to corporate executives, they get excited about their plans and then you get pulled into it as well and lose your objectivity," he said.

The 'Big Bang'

Of course, criticism of the Wall Street approach to stock research is hardly new. In fact, it dates at least as far back as the so-called "Big Bang," the day in 1975 when the Securities and Exchange Commission eliminated fixed commissions on stock trades, and competition began to drive down profit margins for trade executions.

After the Big Bang, Wall Street houses began to make much more of their money from the million-dollar fees paid by companies that need help issuing stock and debt, and managing merger-and-acquisition deals. Critics say the new fee structure, aided by deregulation in the banking sector, has left Wall Street analysts hopelessly conflicted and under intense pressure not to assign poor ratings to companies that are hiring, or might hire, the analyst's firm for other financial services.

In the Enron debacle, critics say, the prolonged "strong buy" ratings resulted from the extraordinary amount of money the energy-trading company pumped into Wall Street's pockets. Since 1986, according to data from First Call/Thomson Financial, top Wall Street firms made $323 million in fees for underwriting stocks and bonds issued by Enron. Goldman Sachs led the list at $69 million, followed by Credit Suisse First Boston at $64 million and the Salomon Smith Barney arm of Citigroup at $61 million.

In recent testimony before the Senate Banking Committee, Michael Mayo, head of the financial research group at Prudential Securities and a veteran of four Wall Street firms, said that throughout his career he has felt pressure to stay bullish. And he said things are worse than ever.

"When an analyst says 'sell,' there can be backlash from investors who own the stock, from the company being scrutinized, and even from individuals inside the analyst's firm," Mayo said. "The degree of conflict between serving corporations and investors -- based on where the money is made -- is at its highest level in history. If nothing else, this creates an environment ripe for abuse."

Several money managers said the demand for independent research, always higher at the end of a bull market, is greater than ever because of the perceived conflicts facing Wall Street analysts, and fears that other Enrons may lurk around the corner.

"I've always been skeptical of the research coming out of Wall Street," said Edmond Sheidlower, a former portfolio manager for Chase Manhattan Bank and now a partner in Bryce Capital Management, which handles $75 million for individuals and institutions and uses reports from Alpha Equity and other independent research firms. "We use Wall Street analyst reports for general information and ignore the ratings, figuring -- like everyone else -- that they are fairly biased."

Officials at several Wall Street firms defended their analysts' performance on Enron and Global Crossing by referring to Sheidlower's argument. They said their clients -- institutional and individual investors -- value their research less for the ratings than for the models upon which the ratings are based.

"Our clients are not coming to us for 'buy,' 'sell' and 'hold' ratings," said Kate Baum, spokeswoman for Goldman Sachs, which had "strong buy" ratings on Global Crossing and Enron until Oct. 4 and Nov. 21, respectively.

A spokesman for another major investment bank agreed, saying its analysts conduct very sophisticated analysis for very sophisticated customers. "These institutional investors know very clearly what the analyst means," he said.

Even so, critics maintain, these reports are heavily covered by the financial news media and are used by average investors who may not necessarily know that "hold" is often Wall Street-speak for "sell immediately."

In fact, studies show that "sell" ratings now account for fewer than 2 percent of all ratings. Some firms have already moved to institute changes to eliminate possible conflicts and to make their research more critical. For instance, Prudential Securities last year all but eliminated its investment-banking division and changed the analysts' rating system to a simple "buy," "hold" and "sell" formula. Prudential has also moved to increase its number of "sell" ratings.

More recently, Merrill Lynch announced it would ban analysts from owning (and thus perhaps being overly bullish) on stocks they cover. And Morgan Stanley recently eliminated buy and sell ratings in favor of ratings that predict whether a stock is likely to outperform or underperform the market. And they said they would publish statistics showing how often analysts give positive ratings to stocks.

Another solution, suggested by University of Texas law school professor Henry Hu, would be to require that every time an analyst appears on television or in print, he disclose both his stock-picking track record and any investment-banking relationship his firm may have with the company under discussion.

Disclosing investment-banking relationships in research reports would be required under new analyst guidelines recently proposed by the SEC, the National Association of Securities Dealers and the New York Stock Exchange. But some say such a requirement will do little to help individual investors because those investors rarely see the reports themselves and only hear about them through news coverage.

Analysts' track records are what's behind the thinking of Kei Kianpoor, a veteran of Citibank and Credit Lyonnais, and of his new firm, Investars.com. Subscribers can see who has the best track record for each stock. In addition, each research firm's hypothetical portfolio is followed, calculated and ranked. "It's all there in the rankings," said Kianpoor.

Much of Investars' information is free, and subscriptions for individuals cost just $20 per month, something Kianpoor says is intended to level the investment playing field, particularly now that the markets have once again discovered a direction other than up.

"This information has always been relevant to the individual investor," he said. "The difference is that when the Nasdaq was rotating between 4000 and 5000, good research was a luxury, not a necessity."

In addition to getting increased exposure on sites such as Investars and Jaywalk, there are signs that the boutique research firms may begin to promote themselves more aggressively. After years of quietly serving institutional clients, Alpha Equity Research Vice President Todd Campbell said his firm is getting ready to make its reports more widely available on a soon-to-be-launched Web site.

"Individual investors, especially from 1996 to 2000, were able to go out and make money fairly easily without having institutional-quality knowledge," he said. "But now investors want objective guidance about what stocks to be in, and they don't want to worry about what outside factors might be influencing their research."