Jewish World Review April 28, 2003 / 26 Nissan, 5763

David Pauly

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Consumer Reports

It Might Be Independents' Day for Stock Research | (Bloomberg) Too bad more people weren't listening. In March 2000, Precursor Group, an independent stock research firm in Washington, D.C., correctly predicted that the U.S. government would block WorldCom Inc.'s proposed takeover of telephone rival Sprint Corp. -- perhaps ending WorldCom's growth- by-acquisition strategy. WorldCom shares closed at $41.39 on the day of the report.

On Jan. 22, 2002, Precursor Chief Executive Scott Cleland declared, "WorldCom has a dying growth model.'' The shares traded that day at $12.28. Almost a year and a half later, WorldCom has gone bankrupt and its shares are worthless.

Precursor's prescient comments were in sharp contrast to the encouraging words on WorldCom that emanated from Wall Street's big securities firms almost to the end. Subsequently, WorldCom admitted lying about earnings to the tune of $9 billion, and several big firms admitted they'd published fraudulent corporate research.

After such shenanigans, investors -- institutional and individual alike -- should pay more attention to independent research firms. There are scores of them, and they generally sell to smaller brokers and money managers as well as financial advisers.

No Nonsense

Almost by definition, independents are more honest than big investment firms. Independents aren't tempted to gloss over a company's questionable earnings report in hopes of, say, advising the corporation in merger talks. "Independents have never been afraid to use a sell rating,'' says John Eade, president of New York-based Argus Research Corp., whose analysts cover about 300 companies.

Traditionally, the big firms barely acknowledged that an investor should ever sell. Customers were forced to look for such things as a hold rating for a clue that it was time to get out.

By contrast, near the end of the first quarter, Argus Research advised investors to sell shares of 17 percent of the companies it covers. It recommended buying 45 percent. At the same time, Standard & Poor's rated as best buys only 88 of the 1,200 stocks it covered, while recommending that 62 of them be sold. Only 32 percent of S&P's ratings were favorable -- that is, best buys or accumulate -- while 19 percent were unfavorable, sells or avoids.

Money Helps

Independents are about to get a windfall. As part of a $1.39 billion agreement over biased research reports still being negotiated, the biggest firms will fund about $432.5 million of independent research for five years. This financial boost for independents -- plus reform by embarrassed big firms -- should mean better stock research overall for investors.

One of the obstacles to improved research is cost. Big firms have offered research "free'' in exchange for brokerage commissions or investment banking fees. They still have to figure out how to make their research believable and how to recoup its expense. Investors by now should've learned that they get what they pay for. "In the late 1990s, people substituted financial TV for research,'' says Sam Stovall, chief investment strategist at S&P.

While the venality of large firms and the misfortune of three years of falling stock prices have resulted in new respect for independents, the smaller fry haven't suddenly vaulted to the top. Independents produce only a fraction of all research, and rival analysts at big firms are no dummies.

Argus Research analysts still complain that some companies delay returning their phone calls or refuse to notify them of conference calls. And honest research can be wrong. Argus thought it was sticking to its fundamentals during the late 1990s, but Eade says, "That doesn't mean that our rating on Cisco was always right.'' At the moment, however, independents have one huge advantage: Nobody's questioning their integrity.

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David Pauly is a columnist for Bloomberg News. Comment by clicking here.


© 2003, Bloomberg News