Analysts Criticized for Herd Mentality, Laggardly Moves

NEW YORK — On Sept. 27, Priceline.com, the “name your price” Internet service promoted by actor William Shatner, warned that weak sales of airline tickets would crimp third-quarter revenue.

At the time, 16 of the 20 Wall Street analysts covering the company considered its stock either a “buy” or a “strong buy.”

But the company’s warning triggered a rash of downgrades, and the shares plunged 42%, to $10.75 on Nasdaq. Half a dozen other analysts have since piled on with negative views.

Today, with the stock under $6, almost all analysts don’t like Priceline.com.

Which leaves their investor clients to wonder: Why couldn’t one of them have said “sell” at some point in the stock’s long slide from March, when it was still above $100 a share?

Amid the carnage in many technology stocks in recent weeks, Wall Street analysts are facing a barrage of criticism that many have heard before: Why does it take a 90% slide in a stock for analysts to decide something’s wrong?

Or to put it another way: Why do so many analyst downgrades seem to come after the horse is long gone from the barn?

“A company almost has to present itself at the door of Cedars Sinai as a terminal patient before you get downgrades,” said Scott Black, president of Delphi Management in Boston.

Black, a bargain hunter who seldom looks at stocks that sell for more than 13 times per-share earnings, said Wall Street analysts have always run in herds.

To show that the herd mentality goes in both directions, Black cited Walt Disney Co. The stock was out of favor among analysts in summer and fall of 1999, when it was languishing in the mid-$20s. It suddenly attracted a flock of upgrades early this year, after it had leapt above $35.

However, investors tend to be more emotional about money actually lost than opportunities missed. That’s why a sharp market slump--like Nasdaq’s 22% plunge since Sept. 1--always revives old complaints about conflicts of interest between Wall Street stock analysts and their brokerages’ investment banking departments.

Because of the brokerages’ hunger for new stock-underwriting business, critics say analysts are under pressure not to bad-mouth the firms they follow. A stock downgrade, the argument goes, could lead a company to withhold lucrative underwriting deals from the offending brokerage.

There is also the risk of being “frozen out” by the subject of the downgrade, said money manager David Dreman, himself a former Wall Street analyst.

“Say I was a personal-computer analyst and I made a negative call on the industry,” he said. “I could lose all my contacts at the companies and be unable to do my job.”

Generally, Dreman said, it’s far safer for an analyst to be wrong but in lots of company than to be right but out of step.

One analyst who stepped out recently was Ashok Kumar, who follows the semiconductor and personal-computer industries for brokerage U.S. Bancorp Piper Jaffray.

In early August, Kumar downgraded Dell Computer to a “buy” from “strong buy,” saying that the company would not be able to meet its forecast of 30% annual revenue growth.

Sure enough, on Oct. 5, Dell warned of softening sales growth. By the end of that day, Dell shares were down 40% from the point where Kumar made his call.

His timing on Intel was even better. The chip giant was trading near its all-time high of $75.81 when Kumar warned Sept. 5 that chip demand was flagging and price cutting “could turn malignant.” Again, he downgraded the shares to a “buy” from “strong buy.”

Since then, Intel has slid nearly 50%, to $35.69 as of Monday.

Kumar’s boss, research director Thomas S. Schreier Jr., said the Minneapolis-based brokerage tries to encourage independence among its analysts. Gaining credibility among investors is a surer path to building business than always telling companies what they want to hear, he said.

But negative calls are controversial because money managers tend to have a bullish bias, Schreier said. “It’s incredibly difficult to be able--in the face of everyone’s advice--to step out and make a tough call,” he said.

Oddly enough, another U.S. Bancorp analyst, Anthony N. Gikas, set himself apart from most of his colleagues by initiating coverage of Priceline.com on Sept. 29--two days after the earnings warning. His call: “strong buy.”

It remains to be seen whetherGikas will be right in thinking that Priceline was beaten to below its true value, but Schreier said the point is that he could feel confident enough in his homework to go against the conventional wisdom.

But if U.S. Bancorp’s Kumar was correct that the semiconductor and PC businesses were heading into a downturn, why are his Intel and Dell ratings still “buy?” Why not bust them down to a “hold” or even a “sell?”

Even analysts who believe the trend is changing for a stock frequently still list it as a long-term “buy,” or at worst a “hold.” A “sell” rating is usually reserved for companies considered virtually hopeless.

In Wall Street’s insider code, it’s the tone--and direction--of an analyst’s rating change that matters, not the specific rating.

The important thing for individual investors, Schreier said, is to “look at the direction, not the location, of the call.” In other words, if the direction is down, consider it a warning.

Investors should note, though, that breaking away from the analyst pack also has its risks.

Dartmouth finance professor Kent L. Womack said his studies have shown “fairly convincingly” that investors have done better over the years by following Wall Street analysts’ consensus views on stocks than by bucking them.

Given that many big money managers heed analysts’ advice, at least to a degree, a bullish following can keep a tide of money flowing to a stock.

Money manager Jeffrey Bronchick of Reed, Conner & Birdwell in Los Angeles, offered a more jaded view. It’s important for investors to understand that making accurate calls on individual stocks is “only about 15%” of a Wall Street analyst’s job, he said.

The analyst’s main functions are holding hands with institutional clients and supporting the brokerage’s efforts to drum up investment-banking business, Bronchick said.

And because analysts often are slow to downgrade stocks they have believed in, the negative call--when it finally comes--may be just the wrong advice, he said. “Inevitably, a bad ‘buy’ is followed by a bad ‘sell,’ when a stock may actually be at the bottom of a cycle.”

Individual investors who blindly follow Wall Street research are just as much at fault as the analysts who generate it, Bronchick believes.

“If you drink the Kool-Aid along with the analyst, you deserve what you get,” he said.

* Thomas S. Mulligan can be reached by e-mail at [email protected].

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How Wall Street Saw Priceline.com

Here’s how shares of Priceline.com have slumped since August, and how some Wall Street analysts changed their views leading up to, and following, the company’s warning about a third-quarter sales shortfall.

Sept. 15: Jefferies & Co. issues “new buy” rating;

PaineWebber reiterates “buy”

Sept. 27: Priceline.com warns of third-quarter sales shortfall; Merrill Lynch cuts rating to “near-term neutral”; Jefferies cuts rating to “hold”

Oct. 6: CS First Boston cuts rating to “hold” from “buy”

Oct. 11: A.G. Edwards cuts rating to “reduce” from “maintain”

Source: Bloomberg News