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Don't Just Take Their Word for It

By itself, that 'buy' or 'avoid' rating may not mean much. Learn to interpret analysts' labels and read between the lines of their reports.

November 05, 1996|Jon D. Markman

The "buy," "sell" or "hold" pronouncements of brokerage research analysts move stocks today as much as almost any other shred of news. A recommendation by a widely respected analyst can boost a stock 30% or more in a single day.

But for individual investors, the best way to profit from analysts' recommendations may not necessarily be the most obvious (buying on a "buy" tout). Reading between the lines and learning to interpret analysts' labels may be a more lucrative strategy.

It is, admittedly, a challenging game. First, not even the analysts are always clear what their pronouncements mean. What's the difference between a "strong buy" and a "buy"? The difference between "accumulate" and "buy"? The difference between "avoid" and "sell"?

"Most of it is baloney," says Lewis H. Alton, a San Francisco-based independent analyst for institutional investors, who eschews the tags.

Adds Todd Bakar, an analyst at Hambrecht & Quist whose declarations move personal computer stocks with the speed of electrons: "If you ask 30 analysts here about our labels, you'll probably get 30 different opinions."

Kenneth L. Fisher, a Bay Area money manager who ought to be the sort of person at whom such ratings are aimed, thinks they actually can be a contrarian indicator of a stock's value.

"I never pay any attention to them," he says. "In fact, the more positive brokerage reports there are about a stock, the less interested I am in it."

Fisher believes that positive brokerage reports reflect only the popularity, not the value, of stocks. In his view, the more popular a stock, the more it is covered by Wall Street analysts, and the more any good news is already discounted into its price.

Further, many cynics consider the recommendations rife with conflicts of interest--a way for brokerages to hawk the stock of a company they have either brought public or hope someday to gain as a client.

A better way to think of recommendations is to see them as more as sales tags than as rankings--declaring whether an analyst believes a stock is underpriced, fairly priced or overpriced. Institutional investors say they mostly ignore the actual "buy," "sell" or "'hold" labels because they make up their own minds based on the underlying earnings research in the analysts' reports.

The first step in taking advantage of the research is obtaining it. The good news is that if you trade through a full-service brokerage, its reports are free, because you're already paying for them with high commission rates. (See box accompanying this story.)

Next, you need to learn to read between the lines of the reports to determine if a downgrade or upgrade is imminent. Analysts admit that investors must not just look at what they say, but also how forcefully they say it.

Bakar is a good example. His brokerage, a San Francisco boutique specializing in emerging-growth stocks, classifies securities as "strong buy," "buy," "hold" and "under-perform."

A "buy," Bakar says, is a stock an analyst believes will outperform the Standard & Poor's 500-stock index and that is fundamentally well-positioned in its industry. A "strong buy," he says, suggests that the analyst believes the stock will gain more than 35% over the next three to six months.

A "hold" is a stock expected to drift in its current pricing range. An "under-performer," he says, has "fundamentals that really stink."

Bakar says he issues few "strong buy" ratings, communicating favorite buys to the brokerage's retail sales force more with "body English" and by "thumping the table" than with the more glamorous label.

In fact, he said, the most important signal an H&Q client can glean from him is not the ranking itself but the indications that he may be about to change his ranking.

"I might start writing reports that new products are on the horizon, I'll start conveying a more positive tone in my reports and getting the stock in people's faces more," he says, "so that when I do upgrade the rating, it doesn't come out of nowhere, it's not a culture shock."

One of the best recent examples came Oct. 9, when the stock Read-Rite, a maker of computer hard disk components, jumped after Bakar and two other analysts upgraded it from "hold" to "buy." In a spot report issued by Bakar almost three months before the upgrade, the analyst noted that he was impressed with the company and felt comfortable with executives' forecast of an earnings turnaround, even as he maintained his "hold" rating.

Clients who read between the lines in July were apparently buying the stock despite the "hold" label. The stock gained 80%, from $10 a share to $18, by early October before it jumped a few points on Bakar's "buy" recommendation. The stock has since slipped back to $17.75.

The best way to read Bakar: He considers an upgrade from "buy" to "strong buy" more powerful than an upgrade from "hold" to "buy."

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