Being a Wall Street research analyst is a pretty good gig.
At a lot of shops it will earn you a six-figure salary right from the start.
And the checks just keep getting bigger after that.
The lifestyle isn’t the worst either…
You travel around the country and talk to CEOs and CFOs…
…at roadshows and corporate events…you rub elbows with rock stars from the hedge fund and private equity universe.
The good life…
Of course, that’s the story they want you to hear about…
But it’s simply not true.
It’s time I shed the spotlight on what’s really going on.
Wall Street analysts get off the express train each morning and rush up the steps at the intersection of Broad and Wall Street.
They have one goal.
Not to screw up and lose this great job.
Which is why everyone acts and thinks the same way.
The best way to screw up and lose this gig is to be contrarian.
Let’s say everyone on the Street is bullish about a company, but you hate it.
You write a bearish report that points out that they may be cooking the books.
Ten other analysts’ write bullish reports.
Their client’s buying keeps pushing the stock higher.
You get fired because of your client’s losses.
A year later, you are proven right, and the stock crashes.
Here’s the problem: No one cares.
By now, you are living in Jersey with seven roommates and working as a stockbroker for a mid-level firm.
Your biggest hope is that your rich uncle takes mercy on you and introduces you to his rich buddies. Or maybe you just went back home and are selling mutual funds and annuities in Cornfield Bank and Trust lobby.
This isn’t a hypothetical. This is actually what happens to people.
The Risk Isn’t Worth the Reward
Analysts figure out early that their most significant risk is career risk. The best way to avoid that risk is to understand that their research department is actually a marketing department.
The job is to write reports that convince clients to buy stock from the firm.
It’s also to convince potential investment banking clients that you’re good enough at convincing retail and institutional clients to buy that you can help drive their stock higher after the IPO.
If an analyst likes a stock, the analyst rates it a buy.
If the analyst loves a stock (or is an important investment banking client), it’s a strong buy.
If the analyst doesn’t like a stock, it’s a hold. Sell recommendations are rare.
A sell rating is an admission that this business is so bad that you and your firm are willing to forgo any possibility of ever doing business with them to keep people from owning the shares.
If you ever do run across a sell rating from an analyst, it is usually a good idea to look for a short set up. This stock could be crashing quickly.
When you are looking at Buy recommendations, look at the price target. A buy rating with a price target 10% to 15% above the stock price is pretty much meaningless.
A price target 70, 80, and even 100% above the target price?
You have my attention. Let’s read on to see what is going on here.
Breaking Down the Buy Rating
Research analysts spend hours pouring over reports and talking to people at the companies they cover.
They issue estimates of how much money a company will make for the next several quarters and year. Accuracy is prized, and those who guess the magic number can win awards form industry groups.
Most analysts are not that accurate. The range of error for Wall Street earnings estimates makes weathermen look brilliant.
While the level of that estimate does not matter, the direction does. If the consensus estimates are being raised for a given company, that tells me that the analysts are seeing good things happening to this company. They are selling more, margins are getting better, whatever it is something is getting better, and Wall Street things this company will make more money than originally expected.
Consensus estimates that are being continually revised upwards is usually very bullish for the company being reviewed.
The reversals of estimate direction should be watched carefully as well. A company that has seen a string of positive revisions that sees its first negative revision may abut to reverse course.
The inverse is also true. If a company that’s been struggling sees an increase in the consensus estimates, the bottom may be in for the stock.
When dealing with Wall Street analysts, we need to be aware of career risk and how much it guides their decisions.
Most of the time, their actual opinion on the stock is not useful.
Unless it is a sell rating.
What is also very useful is the direction of their estimates for quarterly and annual earnings.
The estimate changes reveal far more information that delivers far more information than a 47-page report with 14,000 ridiculously complex words that may invite an onset of hippopotomonstrosesquippedaliophobia (Fear of Long Words) and extensive pie chart usage can ever accomplish.
Tomorrow, we’ll address a major announcement from one of the top hedge fund managers in the world, and how I plan to make money on several new trends.