A secret about stock analysts you must know! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

A secret about stock analysts you must know! 

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In this issue:
» Mukesh Ambani firm penalised for insider trading!
» Takeaways from RBI's 2013-14 monetary policy review...
» Why economists need to borrow ideas from psychology?
» The US financial markets seem destined to crash!
» ...and more!

It's been a year since the social networking behemoth Facebook launched its IPO. The IPO had led to a storm of lawsuits when it was known that underwriters such as Morgan Stanley, Goldman Sachs and JP Morgan had selectively revealed vital inside information to their preferred clients. Small investors suffered huge losses as a result of this.

Was the Facebook fiasco an anomaly or a norm? Do brokerage analysts really care for the interests of retail investors? Are their views independent and unbiased?

We came across some disturbing answers to these questions. A recent article in the Wall Street Journal carried some findings from a new study of Wall Street stock analysts.

Ideally, what factors should determine the compensation of a stock analyst? Should it not be based on accuracy of recommendations? Should it not depend on impact of recommendation on client portfolios? But not a majority of the analysts believe so. About 67% of the 365 sell-side analysts surveyed believe their rankings in media surveys, "broker votes" and popularity contests among clients are the main determinants of their compensation.

What do brokerage analysts rely on for their quarterly earnings forecast? It seems private access to corporate management is the most important aspect of their work.

The worrying part here is that analysts are careful not to displease the company managements. The study reveals that about 40% of analysts have said that their access to management would be in danger if they issued earnings forecast much lower than the Wall Street average. The sell-side brokerage analysts appear to be more worried about their relationships with management than whether their research helps investors. So if you had any delusions about brokerage analysts caring for small investors, you have got your answer!

Of course, this study pertains to Wall Street analysts. But we believe the conclusions are universally valid. The views and recommendations presented by brokerages may often be driven by motives and factors that may be conflicting with those of investors. As such, investors would be better off not blindly following the guidance of such entities.

Instead believe in advisors whose compensation purely depends on client satisfaction. Where there is no conflict between the customer's interest and the advisor's interest, the transparency is bound to show. Most importantly, while analysts, rating agencies and wealth advisors will increasingly be subjected to regulatory checks, investors themselves need to be careful about which advice they wish to take.

Do you believe brokerage analyst reports are independent and unbiased? Please share your comments or post them on our Facebook page / Google+ page

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01:10  Chart of the day
In 2010, SEBI had directed all listed companies to have a minimum public shareholding of 25%. The deadline for all private companies ends on June 03, 2013. As per an article in Business Standard, more than 100 companies are yet to comply with the shareholding guideline. Put together, these companies are required to sell shares worth Rs 170 bn. The chart of the day shows the companies that are required to offload the most in value terms.

It seems the companies want the deadline to be extended further owing to the poor market conditions. They are of the view that the markets would not be able to absorb share sales of such a magnitude in just a month's time. However, the market regulator has not relaxed its stand on the matter as it believes enough time has already been given to the non-compliant companies. It is worth noting that about 40 companies have lowered their promoter holdings through offer for sale or the institutional placement programme since last year.

Data Source: Business Standard

Transparency and ethics are important to investing. Acting on material non-public information for personal gains violates both these standards. Sadly, it is more often than not the company management that is involved in such violation. The reason being they know more about the company than outsiders. Hence, they can act on price sensitive information for their own advantage.

One such instance came to light recently when market regulator SEBI fined Reliance Petroinvestments (RPL), a subsidiary of Reliance Industries, for insider trading. The case goes like this. RPL bought a chunk of shares in IPCL in early 2007 just before it declared an interim dividend and announced its merger with RIL. This profited RPL via dividends it received from IPCL and capital gains it raked in from the share swap. As such, it made a handsome profit from this deal.

As is the case with all litigations in India, the market regulator took over 6 long years to penalise the Mukesh Ambani firm. The fine of Rs 11 crore is indeed higher than the profits RIL managed to make out of this deal. But is such a penalty enough? Will it deter such instances in future? We're doubtful! Paying a petty fine is an easy exit for such large corporates.

Perhaps, we should learn some lessons from the Raj Rajaratnam case in the US where the billionaire hedge fund manager was sentence to 19 years in prison for being guilty of insider trading! Will that ever happen in India? Your guess is as good as ours. But your hard-earned money certainly deserves Z-level security against risks from such fraudulent promoters!

It would be an understatement to say that financial year 2012-13 was eventful for the Reserve Bank of India. Cumulatively, the central bank reduced repo rate by 1% and the cash reserve ratio (CRR) by 0.75% during the fiscal. Even then the criticism for not stimulating growth rates enough came from all quarters. The RBI itself acknowledged its failure in containing inflation. Food and fuel prices at the consumer level in particular, showed no impact of additional liquidity. Supply constraints and infrastructure bottlenecks thwarted every attempt by the RBI. Global macroeconomic scenario made things look no easier. In fact, in the event of heightened global uncertainty the risk of reversal of capital flows remains a key concern for India.

In its maiden Monetary Policy review for financial year 2013-14, the RBI laid bare its concerns. While the RBI did give some leeway to markets today by lowering the repo rate by 0.25%, the warning was clear. Future rate cuts will have to take three considerations into account. That cheap liquidity is not helping ease inflation. That widening current account deficit is something that the government will have to control sooner than later. And finally, global economic shocks and calibration of quantitative easing may affect Indian markets as well.

Many of us would not have heard of a gentleman named Daniel McFadden. An economist with a Nobel Prize to boot, he has made some interesting observation via an article in The Economist. We know that the idea of a perfectly rational man is central to the discipline of economics. However, as per Mr Fadden, the perfectly rational man is nothing but a myth. In other words, your everyday man is anything but perfectly rational. And the mountain of data to prove this has only gotten bigger in recent times.

In fact, even we would have come across many cases where choices have been made not based on rationality. Instead, they were more a result of personal biases and experiences. For e.g. as Mr McFadden highlights, don't we attach great value to a personal coffee cup than an identical one that isn't? Or don't we fall in love with shares of companies that we've held for a long time despite the obvious rewards from selling? Indeed, there are many such examples, borrowed from a wide variety of disciplines that blow a big hole in the idea of a perfectly rational man. Therefore, it is McFadden's personal view that it is high time economists start borrowing from other disciplines like psychology, biology and neuroscience. Well, we couldn't have agreed more.

Noted economist Nouriel Roubini is not a fan of the Fed's money printing policy. In a recent article in Economy Watch, he has given his reasons for disliking this flood of cheap money. The reasons are threefold. The first is the obvious one. That this flood of money is not really driving economic growth for the US. It is being pumped into the financial market which is inflating the prices of asset classes. This includes the riskier assets. As such, this cheap money has led stock prices soaring in recent times even when the underlying companies are not performing too well. The asset bubbles that are being created will burst eventually and the landing will not be good.

The second and third impacts would be whenever the money printing stops. This is expected to happen in 2 to 3 years. When the Fed switches off the printing press, interest and inflation rates would start trending upwards. If this happens too quickly, the financial markets will crash. If it happens too slowly then there would be new bubbles created as has been seen historically. And these too will eventually burst leading to a crash in the financial markets.

To sum up here are the three outcomes of the quantitative easing program as per Mr Roubini - crash in financial markets, crash in financial markets and crash in financial markets. We quite agree with the assessment of Mr Roubini.

In the meanwhile, the Indian share markets were trading in red. At the time of writing, the BSE Sensex was down by 100 points (0.5%). Sectoral indices represented a mixed bag with banking and auto stocks witnessing maximum selling. However, metal and capital goods stocks were trading firm. Asian equity markets traded mixed with China leading the gains, while Indonesia led the pack of losers. The European markets have also opened on a mixed note.

04:50  Today's investing mantra
"Confronted with a challenge to distill the secret of sound investment into three words, we venture the motto, Margin of Safety. " - Benjamin Graham
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6 Responses to "A secret about stock analysts you must know!"

D Ghosh

May 4, 2013

What will be the impact on stock prices because of dilution in promoter's holding? Particularly WIPRO stock, where the Promoter has to sell huge amount of his holding.
Your input will help us in deciding whether to buy now or later.


Col DS Hoonjan

May 4, 2013

Well, everyone in the game is with the aim to win ie profits. This may appear to be fair when repots given by brokerges are fair and the corporates being reported
upon are doing reasonably good. Investors suffer when reports are coloured to the tunes of a corporate and investors have no means to check the authenticity of the report.Thus reports by Brokerage houses need accountability. Will it ever happen???



May 3, 2013

In my opinion some of the brokerages/analysts reports/views are not impartial.If u listen to different channels the views on one script are totally opposite.


Pinnamaraju V V Subba Raju

May 3, 2013


It is very interesting to read the articles. Thank you very much.

Pinnamaraju V V Subba Raju



May 3, 2013

It will be naive on our part to expect an unbiased analysis.



May 3, 2013

No way. It is all Mili Bhagat i.e. hand in gloves.

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