By almost any measure, the past year has been the sorriest in the history of Wall Street research. The long-debated conflicts of interest between equity analysis and investment banking have become a hot-button topic of national debate and recrimination as angry employees, pensioners and other investors tote up their shocking portfolio losses. Analysts who continued to back companies whose prospects had obviously dimmed or whose accounting practices were suspect found themselves the subjects of public ridicule and prosecutorial zeal.
Clearly, this has not been the simplest, or easiest, of times to produce our 31st annual installment of the best research analysts in America. As market excess turned to market abscess, investors have grown increasingly fed up with bad analysis. In our polling for this year’s All-America Research Team, 54 percent of portfolio managers, buy-side research directors and equity analysts say they simply don’t trust sell-side research (with 56 percent saying it should be totally separated from investment banking).
Yet at the same time, after three years of wretched returns, investors know that good research has never been more important to them. One measure of that: Though we would not have been surprised to have seen voting levels fall off, impatience shading into apathy, just the opposite occurred. This year saw a record turnout of voters, from a record number of voting firms, casting more votes than ever.
The voting produced an extraordinarily close finish, with Citigroup/Salomon Smith Barney repeating in first place by the narrowest of margins over a surging Lehman Brothers, which ties for second with Merrill Lynch. Just one team position separates the top three finishers. For Lehman it’s been a remarkable rise: two years ago the firm finished eighth. In polling that was conducted in May, June and July, Credit Suisse First Boston falls two notches to fourth place, while Morgan Stanley drops from fourth to fifth. Goldman, Sachs & Co. improves by one rung, to sixth. Prudential Securities, which has been publicly championing the independence of its research, moves up one slot, to tenth place.
It bears noting that just about every firm on Wall Street is under intense scrutiny by regulators for questionable practices in research. Merrill Lynch coughed up $100 million to settle charges of deceptive research practices with New York State Attorney General Eliot Spitzer, and Citi/SSB is currently negotiating a settlement with regulators that could result in a big fine as well as a complete separation of its research department from investment banking.
For all the conflict and controversy in the air, the accomplishments of the individual winners on this year’s All-America Research Team could easily be overlooked. That would be unfortunate, since many talented analysts have once again demonstrated outstanding work -- despite brutal market conditions and many distractions. And it hasn’t been mere cheerleading. Many have boldly challenged corporate managements to do better -- often without regard for future investment banking fees; they have unearthed possible earnings shortfalls and downgraded shares well in advance of their peers. And they’ve dissected balance sheets to uncover questionable revenue bookings or other problems. The alleged improprieties of other analysts only further underscore the outstanding efforts of these researchers. Our voters were eager to recognize their achievements.
Take CSFB’s David Maris. The specialty pharmaceuticals analyst was an early skeptic on Irish drugmaker Elan Corp. He first expressed doubts about the company when the stock was trading at 37 in 2000. One year later, with Elan at 55, Maris warned investors that “the emperor has no clothes.” By early September 2002 Elan’s stock had fallen below 3, amid allegations of faulty accounting practices and the failure of its Alzheimer’s vaccine. Maris’s call, say buy-siders, saved them untold millions of dollars and solidified his hold on the first-team ranking in his sector.
But Maris’s stand came at a price. Two years ago, contributors to a Yahoo! bulletin board posted scathing criticisms of Maris’s analysis of the company and alleged that he was in cahoots with a hedge fund that was shorting the stock. Others questioned his basic competence as an analyst; one posting likened him to a “monkey throwing darts.” The postings prompted CSFB to sue 11 people for libel; the suit was later settled. Maris’s highly critical stance on Elan so soured his relationship with the company that he and Elan’s former chairman and chief executive, Donal Geaney, reportedly weren’t speaking when Geaney stepped down this summer.
Then there’s M. Carol Coale of Prudential. In February 2001 the natural-gas-industry analyst told clients that Enron Corp.'s high valuations -- the stock was then trading in the mid-60s -- made it a questionable investment. In October, after Enron announced a $1.01 billion third-quarter charge, Coale was the first analyst to put an outright sell on the Houston energy trader, when its shares were trading at 20. (In early September it traded at 18 cents.)
Coale downgraded energy trader Dynegy in November 2001 at 47 after it announced plans to buy Enron; since then Dynegy has abandoned those plans, seen its chief executive depart and paid a $3 million fine to settle a Securities and Exchange Commission complaint that it artificially inflated its results. As of September 2002 the company’s stock had shed more than 90 percent of its value since the end of 2001. Investors reward Coale’s bold advisories on Enron and Dynegy by pushing her two spots higher to first place.
Morgan Stanley telecommunications analyst Simon Flannery teamed up with the firm’s accounting specialist, Trevor Harris, to take Qwest Communications International’s financials apart. In June 2001 Flannery downgraded the phone service and broadband provider to neutral. In a report, Flannery and Harris questioned the company’s capitalization of expenses, reserve accounting, fiber swaps and equipment sales, among other issues. “We found things that we thought meant it would be hard for them to meet their forecast growth rate,” Flannery says. “There were actions they took that helped their earnings, but we started to wonder whether those growth rates were perhaps not sustainable.” At the time, Qwest shares were trading in the low 30s. Flannery changed his rating again in March, to underweight. The tough analysis prompted Qwest to threaten to sever the company’s banking relationship with Morgan Stanley, according to internal company documents obtained by a congressional committee, and led the New York Stock Exchange to investigate Flannery and Morgan Stanley ( see related People item). In September shares of Qwest, which is now under SEC and Justice Department investigation for its accounting practices, were hovering at about 3.
Flannery’s tenacity helped push him up to No. 1 in the Telecom Services/Wireline category from second a year ago. Harris, in his first appearance on the AART, ranks as the No. 2 Accounting analyst.
Of course, a number of analysts managed to find winning stocks in horrid market conditions. Deutsche Bank Securities’ Daniel Khoshaba, a second-teamer in the Packaging category, recommended Ball Corp. in September 2001 when the Broomfield, Colorado-based can and container maker for the food and beverage industry was trading at 27. Consolidation, he reasoned, would allow Ball to raise prices. A year later Ball shares had almost doubled, hitting the low 50s. Lehman’s Robert Drbul, who vaults from runner-up to the first team in Apparel, Footwear & Textiles, similarly scored when he initiated coverage of famed leather goods maker Coach with a buy in November 2001 at 17. Drbul liked the way Coach management was rejuvenating the company’s brand. The shares traded up 72 percent to 29 in early September, backing off to 25 at the beginning of October. (Coach is also a longtime favorite of Retailing/Specialty Stores first-teamer Dana Telsey of Bear, Stearns & Co., who reiterated her buy in January at 21.)
The work of analysts like Maris, Coale, Flannery, Harris, Khoshaba and Drbul, among many others, should remind everyone of Wall Street research’s original brief -- to provide investors with unbiased information and expert analysis of stocks. Lousy markets and the fallout from the past year’s embarrassing revelations are not likely to disappear soon. Court cases may drag on for years, and other legal and regulatory challenges are sure to emerge in the next few months. Changes in the structure of research departments and the kinds of analysis they publish are already under discussion. However, appreciating the efforts of these and the 381 other researchers profiled on the following pages is a good place to start rehabilitating the reputation of research.
