Published January 30, 2009

Give the analyst a break

By JAMIE LEE

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PEOPLE have been quick to pin blame on the analysts for getting it all wrong last year.

It's easy to see why. During the good times in 2007 and the first half of 2008, several analysts rang up bullish calls that pushed target prices to the roof.

And when actual prices did hit the prescribed levels, analysts pulled out more figures to justify even higher price targets.

Be it price-to-earnings (PE) ratios, price-to-book values, net asset values, net cash, there was always another reason to buy.

Then the storm hit and prompted a flurry of downgrades from many analysts.

In some cases, 'outperform' ratings were stripped down to 'sell' calls in a matter of weeks, raising questions of why analysts didn't temper the ecstatic market earlier.

So how did analysts get it so wrong?

'In a bull market, analysts will look at the stocks and think that the euphoria will never end,' one experienced dealer once said. 'It's not that they are crooks; it's relative value.'

Something that trades at 10 times PE versus the industry's 15 times could be considered cheap, but as the market loses steam amid the economic downturn, 'nobody says it should be 15 - it should be 5', he said.

Based on these relative values and comparisons, the arguments put out are thus rationalised. As one analyst puts it, his job is just to tell a story - or, as the cynics would say, sell a stock.

But it's important also to remember that analysts were just one set of players in the market debacle. Those who consumed their reports - dealers and investors - and the broking firms that hired them, also had a part to play. And, to be fair, the financial crisis that has swept across the globe caught most unawares, including governments.

Not too many care about the soundness of arguments during a bull run. Ask dealers and they'll readily say that when they read broker reports in a soaring market, the arguments matter little. 'We just look at target prices,' said one dealer sheepishly.

Many investors too, during the bull run, were happy to follow the herd in chasing stocks on the flimsiest of stories.

Still, there's no escaping the fact that the structure of brokering research is inherently flawed, and that analysts had failed to warn the market of the impending market crash.

What compounded matters was the fact that one of the key performance indicators (KPIs) set by broking forms for analysts is whether stock prices hit their target prices.

Market watchers say that even if analysts knew the market had run ahead of valuations, they would have been reluctant to make a bearish call because there was every incentive for them to push target prices up while investors were still prepared to chase stocks higher. So there was a collective interest to push prices up and up.

Then, there was the pressure from corporate finance.

While there is a supposed 'Chinese wall' between research and corporate finance, the reality, according to market players, is that this wall is as thin as rice paper.

Analysts felt pressured to release more positive reports on companies which were also corporate clients. It was not unusual to see positive reviews of listed companies from brokerages that had earlier done a placement or other forms of fund-raising for the same firms.

Of course, the house of cards has all come tumbling down now, and like other market players, analysts have also been hard hit, with stories of investment banks and broking firms laying off even their most senior analysts.

The lesson from the crisis is that there must be stronger ethics in broking research, just as there should be in banking and in business.

There should be better disclosure, in research reports, of all the business relationships the broking firm or investment bank has with the company being written on by the analyst, including corporate finance activities.

There should be more thought given to making changes to the KPIs of analysts, so that they will be rewarded more for good, solid and independent work, and less for merely being aligned with the consensus view, and to lessen the incentive to simply push stocks higher.

Until such changes are made, the cynicism that now surrounds analyst reports is unlikely to go away.