The Traditional Role of the Analyst

Analysts are supposed to analyze. This is their traditional role. For the firms that they are supposed to evaluate, they look at the operating and financial conditions, the immediate and long- term future prospects, the effectiveness of management teams , and the general industry outlook in order to make a useful assessment. Most analysts follow a specific industry so that they can gain expertise in a particular sector. For example, Grubman follows telecom stocks and Blodget used to cover Internet stocks. Based on their evaluations, analysts will make earnings predictions . Usually, they will try to predict the quarterly earnings per share (EPS) numbers . These predictions are useful to investors who rely on these estimates to determine the health of the companies in which they may or may not own stock. For example, many investors use P/E ratios (stock price divided by EPS) as an important gauge of a stock's attractiveness as an investment. Some investors like to examine forward-looking P/E ratios. That is, they use a P/E ratio in which the earnings are the estimate for the next year. Therefore, these earnings estimates of analysts are important and useful to investors.

Perhaps more importantly, the analyst is also supposed to make a recommendation to investors. For example, an analyst may recommend the buying or selling of a particular stock. These recommendations usually boil down to one-word or two-word recommendations such as "accumulate" or "buy." Unfortunately, these one-word recommendations are not standardized in the brokerage industry, which may lead to some confusion. Table 8-1 illustrates this point. [5]

Table 8-1. Three Examples of Analyst Recommendations





Strong Buy

Recommended List



Trading Buy



Market Outperformer



Market Perform



Market Underperformer

The table shows the stock rating system used by three different analysts' firms. A quick glance at the table reveals some potential problems. One analyst may use a five-category scale while another may use a four-category scale. Further, while both analysts A and C use a five-category scale, analyst A has two categories below average, but analyst C has only one category below average. Note also that a "buy" recommendation from analyst A is his highest recommendation, but for analyst B, it is only his second-highest rating. Lastly, each firm's definition of a market outperformer may be different. Is it for the upcoming one-year or two-year period? Is 5 percent or 10 percent considered outperformance? The answers depend on the analyst's firm.

However, given the recent scrutiny that is being placed on the analyst recommendations, there has been a trend toward making analysts' ratings uncomplicated. For example, analysts at Goldman Sachs, Lehman Brothers, Merrill Lynch, Morgan Stanley, and Prudential will all be using a three- tier rating system to eliminate the ambiguity between ratings such as "strong buy" versus "buy." [6]

With regard to these recommendations, perhaps the most important point is that they are supposed to be timely . For example, if on a particular day an interested investor finds that the analyst's recommendation for a given stock is a "buy," then that recommendation should reflect the analyst's most updated opinion. This means the recommendation should be updated quite frequently. If a news item breaks that could potentially affect an analyst's recommendation, he or she has to revise and disseminate an updated recommendation immediately. For his or her largest customers, an analyst may even make a phone call. However, a revision to a recommendation may sometimes have to go through an approval process, which may take a couple of days. Lengthy research reports that are mailed out or personally presented to potential investors may also be a bit less than timely. Nonetheless, analysts are generally relied upon for timely advice.

The traditional role of analysts is to conduct thorough analyses of the firms that they are assigned to cover in order to make earnings estimates and trading recommendations. Further, they should also make timely stock recommendations. Are analysts good at these functions?

Infectious Greed. Restoring Confidence in Americas Companies
Infectious Greed: Restoring Confidence in Americas Companies
ISBN: 0131406442
EAN: 2147483647
Year: 2003
Pages: 118 © 2008-2017.
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