Rational Investing: Rating systems no silver bullet for investing

"Buy a stock and when it goes up, sell it. If it doesn't go up, don't buy it." Mark Twain

Ah, there's a mantra for you, one that could be the guiding philosophy of most Wall Street analysts who frequently provide less than totally objective buy-sell recommendations.

The longer one is in the investment business, the more one realizes that not all analysts are good at helping investors make money (there's a big difference between being able to do financial analysis and being able to put it to profitable use).

That's why those of us who have been around several decades have our own means of "handicapping" sources of research and analysts ... and rating systems.

When I entered the investment business in 1968, I believed everything I read from my company's research department. It took only a few times of having my head handed to me with a couple of really bad recommendations for me to realize that the analysts weren't financial gods. It got worse when I started looking at weasel words such as accumulate, hold, market performer, etc.

While experience has shown that the absolutes by which my mentor Charlie lived were not absolutes, he had a succinct way of looking at recommendations: "You either keep buying or you start selling. There ain't no hold. And don't hold your breath waiting for a sell."

In the article, "The Price of Being Right," in the Feb. 5, 2001, issue of Fortune, the writer presents research that reveals that, "Even during the uncertain, recession-fearing, shoulder-twitching present, more than 70 percent of the 27,000 analyst recommendations tracked by First Call/Thomson Financial are buys or strong buys. That compares with a minuscule 1 percent for sell ratings of any kind."

After all, how easy would it be to keep your job as an analyst if you were putting out sell ratings on companies your corporate finance division was wooing, especially when major Wall Street firms' corporate finance activities normally generate far greater revenues than do commissions on customer trades?

Don't misunderstand. I am not condemning all research. Rather, I am simply suggesting that you be aware of any relationships between the company whose stock is the subject of a research report and the company issuing the report. If you are uncomfortable with the credibility factor, do as you would for a medical diagnosis get a second opinion. Where? Ask your professional investment broker.

Speaking of magazine articles, check out the Feb. 5 issue of Forbes. What you read here in the SBJ in the fall of 1999 value stocks should be acquired and tech stocks with high p/e's should be avoided Forbes is recommending now.

That's after the S&P Barra Value Index returned a positive 4.8 percent for 2000 while the S&P Barra Growth showed a -22.5 percent and the NASDAQ Composite a whopping -39.3 percent.

That wasn't meant to sound smug or self-congratulatory, but just to point out that investors who act rationally and who don't shift their paradigm daily can do well. Note, I do not mean extremely well in absolute terms in a difficult market like last year, one of those years when avoiding striking out was more important than trying to hit home runs.

Which brings me to a fact of behavioral finance: In good markets investors prefer superior relative returns, as in, "My account was up OK last year, but my broker didn't outperform the S&P 500," and in bad markets it's absolute returns. "So what if the market was down, I only made 2.5 percent. I could have done better in a passbook." (A corollary is: The investor buys all the winners, while the broker sells him all the losers.)

Those are the kind of comments sometimes heard from investors who have never written down goals, required rates of return and risk tolerance, and then assembled a portfolio that meets those requirements. Sound like anyone you know?

If you are nodding your head and thinking that it could be you, then set the time aside to correct the problem and gear yourself for success in 2001 through rational investing.

(Clark Davis is a 30-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money management company. Questions or comments can be directed to him by mail via The Springfield Business Journal, 313 Park Central West, 65806 or by e-mail at sbj@sbj.net.)