ANALYST WATCH: Policing the experts

4 min read

For better or worse, equity analysts have a considerable impact on how individual stocks perform by virtue of their recommendations and research reports. Last week, the Wall Street Journal unveiled something of a report card on the best-performing analysts and firms in 1999.

The Journal identified the top five analysts in 55 different sectors based on both their stock picking prowess and their ability to accurately predict quarterly and annual earnings of the companies they follow.

Keep in mind, however, this is strictly a quantitative measuring stick that doesn't take into account a bunch of other important hats these people wear. Internally, as much as the praise is welcome, you have to assume these firms are more interested in the volume and, more important, the quality of the deals they bring in and help underwrite.

But this annual review gives investors a good thumbnail sketch of how good these analysts are at picking stocks and predicting their fiscal performance.

Most analysts chose not to comment about this year's rankings. It's hard to say if that's because they don't like to toot their own horns or if they're afraid to jinx themselves in the coming year. Those who weren't at the top of the charts had more obvious reasons for not returning phone calls.

One would assume the usual suspects from huge firms such as Merrill Lynch, Goldman Sachs and Salomon Smith Barney would take the majority of the awards.

However, the results proved what many financial journalists have known all along: Some of the best analysts are quietly doing their work at some of the smaller firms around the country.

Not surprisingly, Merrill Lynch analysts walked away with the most awards, followed closely by Salomon Smith Barney, Goldman Sachs, Bear Stearns and CS First Boston.

One analyst who did comment on his award was Needham & Co.'s former chip analyst Tad LaFountain. He finished fourth among the 32 analysts in his group in the stock-picking discipline.

Stock-picking performance scores were calculated on the basis of the estimated performance, including price changes and dividends, of each eligible stock an analyst covered in an industry, with the results weighted according to the strength of each recommendation.

For a stock rated a "1," or "strong buy," the return was multiplied by 2; for a stock rated a "2," or "buy," the return was multiplied by 1.5; for a stock rated a "3," or "hold," the return was multiplied by 0; for a stock rated a "4," or "sell" the return was multiplied by -0.5; for a stock rated a "5," or "strong sell," the return was multiplied by -1.

You get the idea.

LaFountain checked in with a score of 1,009.8. Not bad considering the mean score for analysts in his sector came in at 466.9.

Pacific Growth Equities analyst Sandy Harrison led the pack with a stellar score of 1,829.4.

Those who read this site with any regularity know that LaFountain has been praised and bashed for his ratings on semiconductor stocks, especially Intel (Nasdaq: INTC) and Advanced Micro Devices (NYSE: AMD), in the past year.

LaFountain was clearly pleased by the Journal's report.

"Several months ago, we had a conversation in which you related that several other analysts had questioned my ratings," he wrote in an email. "I hope they read the WSJ "Best of Wall Street" section last Tuesday when the Journal listed the leading stock pickers from over 3,300 analysts. As I've said, my discipline isn't perfect, but I continue to believe that virtually any discipline beats an approach that doesn't have one."

So it's obvious that these guys are paying attention to the report and take it seriously.

And they aren't the only ones taking note. It's no secret that analysts who enjoy a particularly strong year often find themselves moving on to larger firms shortly thereafter.

Chase H&Q's Paul Noglows ranked No. 2 in the entertainment sector's stock-picking category and No. 4 in the Internet sector's earnings forecasting division.

This tells us two things: He had a very good year, primarily due to the strong performance of stocks such as AOL (NYSE: AOL) and Broadcast.com, which is now owned by Yahoo! (Nasdaq: YHOO). Also, the line between entertainment and Internet technology has become hopelessly blurred.

"It's fun to get recognized but I've always had the view that all of this is pretty fleeting," Noglows said. "Did it sum up everything I've done in the past four and a half years? No. But at the end of the day, it's nice to get recognized."

Conspicuously absent from either of the Internet categories top five was Merrill Lynch's oft-quoted Henry Blodget. Morgan Stanley Dean Witter's Mary Meeker managed to crack the top five in Internet earnings projections but not in the stock-picking category.

Stephen Sigmond at Dain Rauscher Wessels enjoyed another strong year, finishing in the top five for both stock picking and earnings forecasting. UBS Warburg's Michael Wallace was equally impressive, finishing second in the earnings division and fifth in the stock-picking category.