Analysts "Hot Buys" falling way, way behind their "Dump It" stocks

Back in March, here and here, I detailed two model portfolios, one of which analysts said was going to underperform, while the other portfolio was the subject of numerous "strong buy" analyst recommendations.

As originally suggested, these look like they have turned into valid contra-indicators, with the "strong buy" portfolio, now displaying an average loss of -20.0% (similar median loss), and with only 4 of the stocks having any type of positive return. (Prices measured at market close on Friday Aug 11, 2006)

On the other side of the coin, the underperform portfolios, both in the Canadian and US versions, have both produced a positive average return. This has amounted to an average gain of +5.6% (median of +5.7%) for the Canadian stocks, and +3.7% average (+7.5% median), for the US stocks.

This again suggests that "value" stocks remain consistently underestimated, even (especially?) by professional analysts. (Follow link contained here and here to see possible reasons why).

Makes one wonder why they'd have any money in almost any conventional mutual fund, (with a few notable exceptions [Bill Miller, Marty Whitman, etc.])? Next time your broker trots out the "strong buy" recommendation, it's OK to leave the room screaming,

No, you'll never take me alive ... or my money ...

JW

The Confused Capitalist

Chasing Growth at any Price - uh, like NOT!

I couldn't make up my mind about the title: I thought that "Recipe for Diaster: Growth at any Price" was too melodramatic. Nevertheless, it's a trap that many investors fall into.

I was reminded of this when I read this morning's paper and the Whole Foods (WFMI) decline was discussed in some detail. The three analysts in the paper (not the three stooges, no), suggested that Whole Foods was going to be able to grow its net income at about 15% p.a. over the next three years. That's pretty good growth, and it can make a fine stock pick IF (if) you don't pay too much for it.

The three stooges (sorry, analysts) then proceed to put a PE ratio on the projected earnings of between 35 to 39 and, voila, the target price of $60 to $70 is achieved.

PE of 35 to 39? Are we still on planet NASDAQ, circa 1999-2000? As I understand it, earnings growth for the S&P 500 is projected at around 11%, and has an aggregate PE of about 17. Whatever would make you double your projected PE (and then some) for growth only slightly higher than the average? And they can recommend this to clients?

Buying growth is fabulous! Paying too much: NOT! A recipe for mediocre returns, at best. Smart investors always watch for value.

JW
The Confused Capitalist

The Tortoise and Hare Portfolios

Back in mid-March, I profiled two model portfolios, based on aggregate analyst recommendations. One, nicknamed "The Tortoise" portfolio, was designated by analysts as an "avoid" situation, while analysts were universally effusive in their praise of "The Hare" portfolio.

At the time, I suggested that those rankings could well be reversed in the real world: that is, the Tortoise Portfolio could well outperform the Hare Portfolio.

I recently checked in on them, and as of May 24, here's how they've been doing:

• The US Tortoise portfolio: -5.5% (Benchmark S&P500 [via SPY] -3.7%).

• The US Hare portfolio: -10.9% (Benchmark Nasdaq Index [via QQQQ] -6.1%)

I guess I'd have to give this one to the Tortoise to date; although both lost against their respective benchmarks, because while the Tortoise lost 48% more than the benchmark, the Hare lost 78% more than it's respective benchmark.

• The Canadian Tortoise portfolio lost 1.1% over the same time frame, compared to it's benchmark, the TSX/SP60 index (via XIU) which had a loss of 6.2%.

So, to date, the Tortoise portfolios are beating the Hare portfolio. We'll check in again later to see how they're all doing.


JW

The Confused Capitalist

Corporate Reason in the Age of Analysts

Brilliance is sometimes simply being willing to say the obvious and to stick with it. On the one hand, we have the myopic analysts, and on the other, we have a few select folks like superinvestor Warren Buffett and company.

Contrast the rationale of analysts found in the prior link, with the recent words (2005 Chairman's letter) of Warren Buffett:

"Every day, in countless ways, the competitive position of each of our businesses grows either weaker or stronger. If we are delighting customers, eliminating unnecessary costs and improving our products and services, we gain strength. But if we treat customers with indifference or tolerate bloat, our businesses will wither. On a daily basis, the effects of our actions are imperceptible; cumulatively, though, their consequences are enormous.

When our long-term competitive position improves as a result of these almost unnoticeable actions, we describe the phenomenon as '“widening the moat.' And doing that is essential if we are to have the kind of business we want a decade or two from now. We always, of course, hope to earn more money in the short-term. But when short-term and long-term conflict, widening the moat must take precedence. If a management makes bad decisions in order to hit short-term earnings targets, and consequently gets behind the eight-ball in terms of costs, customer satisfaction or brand strength, no amount of subsequent brilliance will overcome the damage that has been inflicted.

Take a look at the dilemmas of managers in the auto and airline industries today as they struggle with the huge problems handed them by their predecessors. Charlie is fond of quoting Ben Franklin's 'An ounce of prevention is worth a pound of cure.'

But sometimes no amount of cure will overcome the mistakes of the past."

Something to think about the next time you're pondering an investment ...


JW

The Confused Capitalist

Analysts say this portfolio will underperform

It's a given that almost all stocks that analysts follow have a "buy" or "hold" rating. For instance, in work done by the The Globe and Mail's Rob Carrick, of the 500 S&P stocks, only four could be found that had a consensus "sell" rating. Only a single S&P500 stock garnered a consensus "strong buy".

So with the idea that these "strong buy" or "sell" ratings could be an indicator of future outperformance (academic work has shown that, on average, "sell" rated stocks outperform the broader market), the S&P500 and Nasdaq stocks that have garnered a consensus "sell" rating are presented, together with their stock symbol and closing price at March 16:

• Aether Holdings - AETH - $3.27
  
• Creative Technology - CREAF - $7.29
  
• Dillards - DDS - $26.43
  
• Eastman Kodak - EK - $29.27
  
• Ford Motor Co. - F - $7.93
  
• General Motors - GM - $22.22
  

The first two are Nasdaq-listed stocks, while the later four form part of the S&P500.

And for our Canadian readers, there a similar analysis of the S&P/TSX composite yielded the following TSX listed-stocks:

• Advantage Energy Income - AVN.UN - $22.95
• InterOil - IOL - $15.99
• Prime West Energy Trust - PWI.UN - $33.59
• Royal Group Technologies - RGY - $10.22
• Sobeys - SBY - $38.30
• Sears Canada - SCC - $17.85
• Tesco -TEO - $21.48
• Torstar - TS.NV.B - $22.85

With the exception of the energy-oriented Canadian companies, most of them appear to be in unloved industries - usually a deep-value investors first good sign! We'll follow this portfolio, euphemistically named "The Tortoise Portfolio", periodically to see how it's doing against the broader market.

Very soon in the future, we'll also present the opposite portfolio; one in which the consensus ratings are only "strong buys", which we'll nickname as "The Hare Portfolio". Due to the boosterism here, a few adjustments had to be made to whittle the list to a manageable amount. Stay tuned.

JW

The Confused Capitalist

Myopic Analysts?

Should stock analysts be judged by the same criteria that they seek to judge company CEOs with? Or would that be too myopic?

Perhaps that would be unfairly demanding a higher standard than that seen in our investing society today - the ability to exhibit some patience during trying times. Seems as if our society doesn't have too much patience anymore, whether that is waiting for improvement in corporate fortunes, or waiting for our stocks to produce outperformance. And hence the unbelievable turnover in some mutual funds, as much as 75-150% annually.

According to The Seven Sins of Fund Management (warning: link is a 105 page pdf), the average holding time for an NYSE-listed stock is now just 11 months, in comparison to an average of eight years in the mid-1950s. Does anyone think that the average investor returns are significantly better due to all this frenzied trading?

In light of this, a recent news item caught my eye ...

"Turf CEOs after five poor quarters, analysts say"

According to a recent survey of 282 analysts, based in North America, Europe and Asia - conducted by Hill & Knowlton Canada - up to 52% of them will forgive poor financial performance for three quarters, but by five quarters, their collective patience has run out. After that, they say, the CEO should be replaced.

Which of course begs the question on my part - would these analysts be willing to subject themselves to the same criteria - i.e. if their "buy" picks don't outperform others in the sector over that same time frame, would they acknowledge their failings and leave?

No?

Hey, just asking.


JW

The Confused Capitalist

Blogosphere pounding analysts

Ding, ding: Round one!

Well, analysts of all sorts are taking a pounding lately in the blogosphere. Many critics have latched onto the sub-par record of analysts in predicting anything, including picking winning stocks, something recently noted in the research study done by European investment house Dresdner Kleinwort Wasserstein, in The Seven Sins of Fund Management (note: link is a pdf file). I don't know if scathing is the right word for some of the conclusions reached therein, so I'll simply quote directly ...

For those of us who think longer term, it would be nice to think that these disturbing findings were merely a reflection of the wider mania that was the investment landscape in 1999. However, our simple analysis of consensus analyst current recommendations and their characteristics, reveals something deeper behind the analysts' behaviour. In the US, the stocks most favoured by analysts tend to be expensive in terms of PE, price to sales, and price to cash flows (PCF). They tend to have very low dividend yields, and very high expected growth rates. They also have high price momentum over the last 12 months.

and further ...

Price momentum appears to be one of the strongest inputs into the analysts' recommendation structure. This tells us something about analysts' time horizons. Price momentum effects are generally found up to around the 12-18 month mark. Beyond that you tend to observe reversals. That is to say, at time horizons beyond 12 months, past losers start to outperform past winners (by 8% in year two on average between 1980-2005).

Noting the poor record of stock selection, a sample reading of current blog comments includes the Nyquist Capitals' blog that recently highlighted one analysts "hold" recommendation of Intel through a recent price rise, his subsequent "buy" recommendation near the price peak and subsequent decline, and then his current revised "hold" recommendation as the price has fallen again.

Peridot Capitals' blog lambasted another analyst for his timing in ditching his Sherwin Williams "buy" recommendation during its recent lawsuit troubles, right at the nadir of its two day plummet. Within days, it subsequently gained about 20% over that intraday low. Peridots summary comment was ... " ... analyst stock picks won't make you any more money than a monkey will throwing darts at the Wall Street Journal stock tables." OUCH!

The Stalwarts blog takes offense at a pointed rebuttal by Michael Eisenberg of Benchmark Capital, wherein Mr. Eisenberg accuses the blogosphere of "drinking its own kool-aid".

Jab, counter-jab. Round two forthcoming, I'm sure.




JW

The Confused Capitalist