On Oct 13, 2000, Abby Cohen, the famous queen of Wall Street (Goldman-Sach's pays millions of dollars for her insight), said the market was undervalued by at least 15%. Mostly because of her comment, the whole Nasdaq market soared 230 points the next day to 3316.

Other analysts have helped a company's stock go up by upgrading their stock rating, for example from buy to strong-buy, or contributed to a stock's plunge by changing their rating downward from say, market-outperform to just market-perform or hold.

But isn't this their job, to inform investors about the prospects of the companies that the analyst follows? Sure it is, but they do a lousy job of it.

After giving a stock a buy or strong-buy rating, the analyst hesitates for months to downgrade it, even if they know that they are dead wrong. And even then they may only downgrade it from buy to hold or from strong-buy to accumulate.

When Enron had already dropped 99%, only 1 of 14 analysts rated it a sell, and 5 still rated it a buy or a strong-buy (source Thomson Financial/First Call).

All analysts seem to over-rate, so strong-buy means buy, buy means hold, and hold means sell!

So it’s “blah,blah,blah. You listened to me and lost your shirt? Well, hang on to your pants.”

Here is a quote from the May 29, 2001 issue of the Investor's Business Daily: "When you see an analyst on TV, hit the mute button ... analysts are divorced from reality."

It's easy to find examples:

• RF Micro Devices - All analysts rated it a buy or a strong buy when it was at almost $90, none said if was just a hold or sell. Lost 92%.
• 24/7 Media - Nobody rated it sell. Dropped from $60 to 40¢. When it was down to 10 bucks, analysts still rated it a strong buy with a target price (what they believed it would go up to) of $50.
• Enron - Nov 8, 2001, 3 weeks after hidden losses were revealed and 2 weeks after the SEC launched its investigation, 10 of 15 analysts rated it buy or strong-buy.

And take a look at these (I could give you hundreds more)
 

In May of 2002, Merrill Lynch was fined $100 million for giving buy-ratings on companies for the sole reason that these companies were a big Merrill Lynch customer.

Even though the investment bank that the analyst works for, may have a vested interest in the companies that they rate, most analysts don’t make lousy recommendations because they are corrupt or stupid, but rather because they really are just optimistic.

On July 25, 2000, one day before Amazon.com was to report huge losses of $300 million for the quarter, no analyst rated Amazon a “sell”. But all 25 people covering the company rated it buy or strong-buy. A few hours before the announcement, Holly Becker, of Lehman Bros (maybe feeling a little guilty), reduced her rating from buy, down to neutral (reading between the lines, this meant sell). Lehman Brothers almost fired her.

Do the financial magazines do any better at picking winners?

Well, take a look at the portfolio recommended by Worth Magazine:

And I quote: "The editors chose the companies listed here on the basis of their sound business plans, high-quality products, solid finances, efficient operations, and capable managers ... in markets with the potential for explosive growth."

April 2001, the Worth Portfolio of stocks was down 44.4% for the past 12 months and included Yahoo (down 81%), and Sycamore Networks (down 75%).

The magazine’s only winner was (take a look at this) Enron, up 14% to $77.90. The following 6-7 months would only get worse, a lot worse. Enron would fall to 26 cents, and the other hot picks would fall another 40-50%. This was while the editors of Worth Magazine were still recommending them.

Then there are the experts that write books on investing, whose poor judgment leads them to make recommendations on the “best” mutual funds or “sure-fire” stocks. One Certified Financial Advisor's book said to buy Lucent Technologies, “at any price, it's a bargain”. At that time, Lucent was selling at over $60. It would fall to $6 within a year, and was recently trading as low as $1.31.

When looking for good companies to invest in, following the crowd can sometimes work for a few weeks or possibly even months, but this is a good way to get burned. Listening to the "experts" does not equal research.

Even though market analysts make many bad calls, I shouldn’t be making fun of them. For every bone-head rating they announce, there are really plenty of times they are proven to be right.

Two independent studies, one a joint effort of Stanford University and the University of California, found that following stock market analyst’s recommendations beat the general market by about 4%. But this was without trading fees factored in. Both studies noted that all your extra gains would be wiped out by the trading costs of the necessary 400% turnover in your portfolio.

But another study of 89,200 ratings, found that the “hold” rated stocks outperformed the “strong-buy” rated ones by 1.3% over the next 12 months.

So the bottom line is:

1. Analyst’s ratings can be useful

2. Don’t bet the farm just because a stock’s rating is a “strong buy”

Don’t hold on to a dropping stock just because the analysts doesn’t say “sell”. How can an analyst be telling clients month after month to “buy”, and now all of a sudden say “whoops, I’ve changed my mind, sell the junk!”?

One analyst at Banc America Securities, after all 9 of his “buy-rated” internet stocks dropped to nothing, actually wanted to take credit for telling everyone that he saw it coming and had stated so in his research.

What had he actually stated, and where was this gem of insight noted? Buried in a separate 54 page report, he wrote that he was “cautious”. What a genius.

When WorldCom admitted that they had failed to properly disclose $3.2 billion in current expenses, and a month later another $3.8 billion WorldCom lie would be discovered. This is after the stock had already fallen from over $60 down to around $1.50. (It’s now trading at 12 cents).

Jack Grubman, the ace telecom analyst for Salomon Smith Barney and a long-time champion of WorldCom stock, had just finally downgraded his recommendations. He said the downgrade “had nothing to do with WorldCom’s troubles”. A month later he would quit his job where he had earned as much as $20 million a year.

Back to Abbey Cohen. I know I shouldn’t pick on Ms. Cohen, but anyone who earns millions of dollars for her advice should either get it right or publicly admit “I don’t have a clue”.

In the May 22, 2000 issue of Business Week Magazine, she predicted “the end of 2000, the S&P 500 index will be trading around 1575 … it should reach 1625 in the spring of 2001”

The index dropped of course, and today, July 19, 2002, the S&P was at 860.

Her prediction for the Dow at the end of 2002 is 13,000. Today it dropped to under 7900.

No matter how knowledgeable these people may sound, you can get just as good a prediction from a psychic by calling one of those 900 numbers. A stock market expert’s predictions are nothing more than a simple guess, and your guess is as good as theirs.

Other Stock Market Basics Topics:

1. Stock Market Investing – the Right Way
2. More Stock Marketing Investing
3. How to Pick Winning Stocks
4. The Golden Rule of Investing
5. Avoid Psychological Traps to Have Successful Investing
6. Changes in Stock Values Can Be Big Numbers
7. How to Invest Smart
8. Stock Advice - Important Selling Rules
9. Poor Stock Buying Decisions
10. Market Indicators
11. Stock Market Cycles
12. When a bear stock market may not be a bear market
13. Stock Index Futures
14. Four Things that Affect Stock Valuation
15. What is a P/E ratio?
16. Value Investing
17. Cheap Stocks
18. What is a Financial Statement?
19. Analyzing Financial Statements
20. Stock Market Tip - Red Flags to Look For When Investing?
21. The Annual Report – How to Read
22. Stock Market Analysts – Stock Market Advice and Tips