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Analyze them
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October 25, 2000: 6:33 a.m. ET
Stock analysts talk a good deal, but do they play with a stacked deck?
By Staff Writer Rob Lenihan
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NEW YORK (CNNfn) - In ancient Rome, the great moral question was: "But who will guard the guardians?"
A lot has changed since then, but in the financial arena, where life is harsh and information is crucial, investors may want to know who is watching the people watching the stocks.
Behind many large publicly traded companies, you'll find an analyst wielding an opinion. They're all over the media, ready to tell you what's hot on Wall Street. Their recommendations can move a stock dramatically in the course of a trading day.
Analysts break down into two species. The buy-side analysts work for mutual funds, large insurance companies or pension funds. They find the stocks their institutions can profit from and their reports are not available to consumers.
The sell-side analysts work for brokerage firms and track particular stocks in certain industries. They appear on television and are quoted in newspapers and on Web sites. Consumers can hear what these analysts have to say. But how much should they believe?
Cheerleaders?
Market watchdogs say sell-side analysts are often faced with a conflict when they recommend stocks.
"The larger brokerage firms have a substantial investment banking operation," said Jeffrey Hooke, author of "Security Analysis on Wall Street," published by John Wiley & Sons. "Generally speaking, the fees from investment banking are superior to the sale of stocks. So in order to be offered investment banking clients, or potential investment banking clients, an analyst is often reduced to being a cheerleader, saying what a great stock he's covering."
Issue too many negative ratings, Hooke said, and the analyst risks angering the client, who may then cut investment banking activities with the firm.
"If they issue a negative recommendation," he said, "that usually causes the stock to drop and corporate executives don't like that. More often than not, they refuse to talk to the analyst, who depends upon information."
NASD Regulation, which oversees all U.S. stockbrokers and brokerage firms, has a manual of rules governing the disclosure of information and advertising, correspondence, and sales literature, which includes research reports.  Among other provisions, members recommending a particular stock must disclose if they own options, rights, or warrants to purchase any of the securities of the issuer whose securities they are recommending, and if they were a manager or co-manager of a public offering of any securities of the recommended issuer within the last three years.
Chuck Hill, director of research at First Call, a stock research firm, said the wall dividing the research department and the investment banking side at brokerage firms has crumbled over the years.
"When I was an analyst, the biggest share of my bonus came from the research department," he said. "I was under no pressure to do a deal. If you got a little extra from the investment side, that was the frosting on the cake. Today it's the cake."
On Monday, new regulations regarding financial information took effect. The Securities and Exchange Commission's Regulation FD (Fair Disclosure) requires companies to disclose profit warnings, earnings reports and any other information it issues to analysts simultaneously to the public via press releases or other notifications, giving Main Street investors a level playing field when it comes to picking stocks.
Legwork
Experts say retail investors should do their own homework when researching stocks and bear in mind that not all analyst reports are created equal. Hill said hard work separates the good analysts from the rest of the crowd.
"Look at the research and read it," Hill said. "See if it sounds like somebody's done some work on the outside. Did they speak to a group of customers or suppliers or competitors? Or does it sound like something the company was telling them?"
Hill also said the five-year growth rate is a better indicator of corporate health than the current quarterly estimates.
"I don't think analysts purposely lie into the camera," said Brian Orol, a certified financial planner in Raleigh, N.C. "The investment business is really built on reputation, so if an analyst gets a reputation for shilling for a certain company, I would think he or she wouldn't be taken seriously." 
Orol advised consumers to check a brokerage's Web site, see what stocks the firm has recommended and what stock the analyst has recommended in the last six months, and check the track records of both. Also check the recommended company's Web site.
"The best companies look for year-by-year increases of 20 percent-to-30 percent," he said. "If an analyst says a company's revenue is going to jump 50 percent, that's a red flag. It's not necessarily dishonest. But it should certainly trigger something in your mind."
Mike Taglich, president of the New York firm Taglich Brothers, adds that investors must be realistic.
"There's no such thing as a free lunch," he said. "If they're not paying somebody for research, they're not going to get good research. You're not going to be able to beat Wall Street investors at their own game."
Taglich suggested investors only buy stock in products they purchase as consumers. Average investors should also consider buying some annuity style stocks, such as the local savings and loan, railroads, or smaller oil companies.
"You can afford to be more patient," he said. "You don't need to be in this week's hot sector to keep your job. You can do your tax planning and you won't get eaten alive in transaction costs." 
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