Buy, sell and hold: how analysts shape our views on stocks
If fund managers followed the advice of Shaun Cousins, they would have avoided the Billabong wipeout.
If fund managers followed the advice of Shaun Cousins, they would have avoided the Billabong wipeout.As the surfwear company launched a capital raising in May 2009, the JPMorgan retail analyst shifted his recommendation from "neutral" to "underweight".Cousins was largely a lone voice in suggesting his professional fund manager clients stay away from Billabong shares.He held on to the underweight call as the stock seemed to be catching a better wave. Billabong moved from $8.07 from the time of underweight recommendation to touch as high as $9.54 just a few months later.But Cousins held tight. He pointed to the cyclical headwinds facing Billabong as well as some more company specific problems such as high levels of debt and a decision to open retail stores.Then from the start of 2010, things started looking shaky for Billabong - as well as the broader retail sector. They began to fall on broader concerns of a decline in spending, cool summers in its main markets of Australia and North America, while the debt levels also weighed on sentiment.Yesterday, Billabong shares were trading at $1.39. The saving to fund managers from the time of the call was more than 80 per cent.Cousins, who was named top retail analyst in the latest annual ranking of analysts by consultants East Coles, says retail stocks can be a tough sector to model."You need to understand how the external thematics impact the numbers," Cousins said.The East Coles survey, exclusive to the Herald , shows trading powerhouse UBS retained its top spot among nearly 50 broking houses in the rankings of overall research. This is a position it has held for several years, dominating specific sectors from banking to diversified minerals to gaming.Likewise, Macquarie Equities, which has one of the biggest stockbroking arms in Australia, also held on to its second-place ranking. However, Deutsche Bank moved up several notches in the latest survey, moving from eighth to third.To compile the rankings, East Coles surveyed the nation's biggest fund managers, which collectively oversee nearly $47 billion in stock investments. The managers were asked to name the stockbroking teams they considered their most important sources of advice on investments in more than 20 sectors including economics.The answers were weighted by the amount of trading commissions the fund manager paid to brokerages - between $1 million and $1.5 million on average."We're very committed to research both here and around the world. I think the line that people like to use is that research is a commodity. But our attitude is that good research isn't and it's pleasing to get that recognition from the institutions," said David Wilson, the head of Australian equity advisory at UBS."We require our analysts to be insightful and build an affinity with the institutional client base."Wilson was the long-time head of UBS's research team, a role recently taken on by diversified financials analyst Chris Williams.Every morning the inboxes of thousands of fund managers and big private investors are bombarded with volumes of stock research from broking houses, sometimes running into hundreds of pages, particularly around profit reporting season. The reports feature the latest deep analysis of listed companies and can be highly technical as charts and spreadsheets spell out trading ideas for fund managers. They also contain measures of investment returns as well as the all-important stock recommendation - the buy, hold or sell call.The information is designed to give the fund manager clients of a broking house an edge in their approach to allocating billions of dollars. Some analysts even compile proprietary data, commissioning surveys of bank customers, or the pricing of insurance policies around the country to find early trends in a particular industry.Before the global financial crisis, some high-profile stock analysts were considered kingmakers. A buy or a sell call from a major broking house could change sentiment towards a stock overnight.However, with few analysts able to pick the magnitude of the moves coming through the financial crisis, calls by analysts quickly lost authority among fund managers.With the downturn in equity markets, analysts are under more pressure than ever. The high cost of running research teams is usually the first to come under the knife when brokerages are looking for cost savings.Analysts can also be unpopular with investment banking arms of the bigger brokerages when they put a "sell" call on a stock and are critical about a company's strategy. This risks putting companies offside, with the loss of lucrative fees.Meanwhile, with markets so volatile, investors have moved to a deeply conservative setting, parking more funds than ever in cash and bonds while moving with the benchmark index when stock picking."Like most fund managers you don't rely on broker recommendations. Generally, I don't believe broker recommendations carry some weight," said Paul Kasian, of Accordius. For an analyst to break through, they need to think outside the square, said Dr Kasian."It's about getting you information that doesn't come from the company. Its provoking ideas - that's what you want to see more of."A second large fund manager said, given global events were the main driver of markets, their approach to analyst research was increasingly using it as an "information tool rather than an investment tool".Brokerage research directors say they are confident they can cut through the macro forces that are driving global markets to come up with useful investment advice.While analysts say having the numbers right remains fundamental, they are increasingly focused on value-added research that includes exhaustive studies of trends and industries.Dr Kasian said fund managers were cautious of the intense pressure analysts can often come under if they deliver a negative rating."Effectively you ignore the recommendation. If you look at the buys, holds and sells, there's very few buys relative to the holds," he said.Even with the events outside the Australian market driving sentiment, Goldman Sachs's media and telecom analyst, Christian Guerra, argues having the right fundamental numbers.Guerra retained the top-ranking for media and telecommunications sectors for the second consecutive year, according to the East Coles survey."Our philosophy as a firm is the numbers are absolutely critical and that's what we focus on," says Guerra, who recently took on the role of co-head of research at Goldman Sachs."If you are really confident in your numbers and confident in your valuation, then if the stock moves away from that level then that's really an opportunity."However, analysts also need to understand the forces driving or weighing on performance of particular companies. This ranges from the outcome of something as far away as an election in Greece to stresses in global credit markets."Obviously we can't control the macro market. Our job is to understand what the macro means for our sector and our stocks," he said."The fact that consumer confidence in Australia is so poor, probably as a result of Europe, then it's hard to see why people would be going out and shopping or spending money. Clearly that has a knock-on effect on advertising," he said.Like retail, media remains a beaten down sector. But Guerra, now into his 12th year as a stock market analyst, has seen some opportunities. For one he narrowed in on "structural growth" stories in the media sector.By structural growth we mean those companies that we think have got really strong franchises, business models and they can increase their earnings independently of the economic cycle.This prompted him to put a buy rating on online car classified site carsales.com in December last year. At the time of the call, carsales.com was trading at $4.69. Yesterday it was trading at $6.44, a gain of 37 per cent for Guerra's fund manager clients.For UBS bank analyst Jonathan Mott, who retained his top ranking for the second year running, the role of the analyst is to help fund managers get a better understanding of the sector they are investing in."At the end of the day picking stocks and portfolio construction is the job of the fund managers. Our job is to help investors formulate a more complete view on the individual banks and the banking sector, and compare this to other investment alternatives," Mott said.Mott has been telling clients this year to focus on the defensive and higher returning banks of Commonwealth Bank and Westpac. He often analyses thematic issues surrounding a stock before crunching the numbers."We spend a lot of time thinking, researching and discussing these thematic issues with as many people as possible to get a thorough understanding of the implications. Once we believe we are on top of the thematic issues we believe we are much better placed to more accurately forecast the numbers," Mott said.Deutsche Bank's Emily Behncke said analysts need to immerse themselves in the industry but keep an eye on broader global macro trends. Behncke was ranked third in two separate sectors this year: steel and building materials."The key is being on top of a best base case and a worst case scenario. And preparing for the worst, and I think that's been the right thing to do in this environment," she said.The focus of Behncke's research is on industry analysis. This involves speaking to a stock's competitors, suppliers distributors and so on,As a result of this Deutsche Bank's earnings estimates for the Australian building materials industry has been consistently below the market - which has proved to be the right call. Materials group Boral has had three earnings downgrades in the past six months.On the positive side, she has backed James Hardie, given signs of life in the US housing market, with that stock outperforming in the past 12 months.Deutsche's Behncke says extensive capital raisings of 2008 and 2009 are still fresh in the minds of most investors, which is why the strength of the balance sheet is now the focus.UBS's Mott supports this, saying since the financial crisis, the way that investors look at stocks has gone through a fundamental shift."The biggest change is the focus on the balance sheet rather than the profit and loss [statement]. For a bank unless we are completely comfortable with its asset quality, provisioning, capital ratios and funding we hardly even look at the profit and loss," he said."Unless the balance sheet is pristine, things can go wrong faster than anyone can predict."Deutsche Bank's head of research, Tim King, nominated financial modelling and good communication as fundamental for any good stockbroking analyst.Even with volatile markets, it was important for analysts to have confidence in their views."Fund managers moving to cash is a function of the difficult markets we're in, but the last thing that a client wants is just because the market is tough we suddenly become short term or change the style. Consistency is very important," he said.King has come through the analyst ranks himself, covering sectors from telecoms to building engineering. He has faced first-hand experience at the pressure analysts can face.In the late 1990s, King incurred intense criticism and had a long-running public battle with the board of engineering conglomerate ANI when he said the acquisition of a sewerage treatment plant would have a negative impact on earnings. Less than two years after the acquisition ANI wrote hundreds of millions of dollars off the investment."Ultimately, I was right on that call. It was a torrid time, but I still have clients that talk about that saying they sold out of ANI and they saved a lot of money," King said.As a footnote, the struggling ANI was eventually acquired by Smorgon Steel.Analysts with negative views can come under criticism from companies during results briefings.Sometimes this even takes the subtle form of company executives refusing to take questions or trying to make out that an analyst's question is stupid or irrelevant. This is aimed at undermining the credibility of an analyst in front of fund managers who also sit in on the briefings.Many have found themselves shut out completely from companies, with access to executives or any additional information cut off. Some companies are known to use friendly brokers to publicly criticise the analyst through the media.King said that even major shareholders in stocks can also get upset if an analyst puts a sell rating on a stock."That's understandable, but our job isn't to make people happy," King said."Our job is to do fundamental analysis of companies and we put the recommendation on the stock based on that analysis and sometimes certain stakeholders get upset."An analysis is based on objective fundamental valuation of a company and all the macro factors - it's not personal," he said.Goldman Sachs's Guerra said he has never worried about what companies thought of his recommendations."I'm happy to talk to the companies on factual issues. If they think we've got our facts wrong then we will always listen to them. We will always correct that. Then really a stock recommendation is a matter of opinion," he said."As analysts we're not here to make companies happy. If we think a stock is a sell because there's earnings risk or it is expensive or we think there's significant structural headwinds - then tough luck."