Trader Talk

Pisani: Sell-Side Analysts Are Blowing It

The declining quality of sell-side analysts:

January retail same store sales: how could the numbers be so far off? Retailers, for the most part, reported numbers higher than expected, in some cases WAY HIGHER than expected:

Limited up 6.0 percent loss of 0.1 percent expected;

Abercrombie & Fitch up 8 percent, loss of 9.0 percent expected

Aeropostale up 11 percent, gain of 5.7 percent expected;

The TJX Cos. up 12.0 percent, gain of 7.1 percent expected.

How could sell-side analysts, who provide the estimates, be so far off?

There's two problems:

1) most companies provide little if any guidance concerning monthly same-store sales;

2) to come up with numbers, analysts look at available data: they look at 12-month trailing trends, the level of promotional activity, and inventories. Then they come up with estimates.

So how come analysts are often so far off, not just with store sales, but with earnings? Because a lot of analysts are just plain terrible.

It is a commonplace on Wall Street that the intellectual level of sell-side analysts has been declining for years.

Why? Because after the lawsuits brought by attorneys-general in 2003, the industry could no longer pay high salaries to analysts. The smartest ones all left to form their own firms or went to work for the buy side (hedge funds).

How much did this matter? The average analyst in 2000, by my guess, made about $1 million a year. Today, I would estimate that an average sell-side analyst makes about $250,000-$300,000 a year.

That's a big difference.

I have been reading analyst reports for 20 years, and I can tell you the quality of some of the research is laughable today. Eighty percent of research I look at is worthless. That's a lot of looking for a few nuggets.

So why don't firms demand higher levels of research? Because they can't pay for it. As a result, they keep analysts on their staff who do pro forma research, pounding out changes in their earnings estimates only when the companies themselves send out a press release. There is very little penalty for being wrong, or having no insight.

Yes, there are a few great sell-side analysts left. They are good writers, have tremendous depth of knowledge, and have extensive contacts.

But there's fewer and fewer of them every day.

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