Thursday, July 12, 2012

"Operation Barn Door" Strikes Again

One of my peeves with the conventional investment business is the investment recommendations of "sell side" securities analysts.  These analysts work for investment banking firms that have a dual charge of promoting stocks through share issuance and also giving investment recommendations to portfolio managers.

The tendency is to recommend buying stocks, which is why there is usually a preponderance of "buy" or "outperform" ratings on a stock, with comparatively few "hold" or "neutral" ratings.  About the only stocks with "sell" or "underperform" ratings are those of companies in obvious fundamental distress such as being in an industry facing long-term decline.

What particularly troubles me is the common reaction to bad news and a plummeting share price.  The typical response by analysts to bad news and a plunging share price is to downgrade their rating on the stock after the plunge in the share price.

We all make mistakes, and we all are entitled to change our minds when given new information.  But what good does it do investors to recommend selling a stock after it has already plunged?  (Hence, "Operation Barn Door," or shutting the barn door after the horse has bolted and is well down the road.)  

Now, there are cases when such a stock will continue to fall.  But the analysts often seem to present their ratings changes as though investors can take advantage of their changed opinion and still get out without suffering a large decline in their holding.

Take SuperValu, which is a grocery retailer that has struggled under a large debt load while facing business challenges from Wal-Mart, Target, and traditional retailers.  I made money on SuperValu shares last year because at the right price, almost anything can be a good investment.  Conversely, even a company as superb as Apple can be a poor investment if bought at too high a price.  (The starting price of an investment is crucial.)

After the close of trading yesterday, SuperValu reported quarterly earnings that were much lower than analysts had forecast.  They also eliminated their dividend on the stock.  In response, today the stock has plunged 50%. In response, several analysts downgraded the shares.  So a shareholder is supposed to sell after absorbing a 50% loss in one day?  

In such a situation, I always admire an analyst who has been negative or neutral up to that point and upgrades the rating in response to a large price decline, because the odds of making money would seem to be much better amid such pessimism and with a much lower entry price for the stock.  As for those analysts who were positive going into the bad news and plunging share price and stick to their position, I admire their fortitude, but question their judgment at having been so wrong.

I won't wade into the question of whether SuperValu is a "buy" today since I haven't followed it for some time.  My hunch is that for one with ample funds for speculation, it might be worth a look.  My main point is that when securities analysts engage in "Operation Barn Door," they provide little value to investors.

Steve Lehman

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