Westpac had its results on Monday. Whenever a big company has results every significant fund manager will come into work the next day to find ten pieces of research (fifty in the USA), one from each of the big brokers, sitting on their desk selling ten different opinions about the result.
Fund managers are like a big bag of chips, and the brokers are like a flock of Seagulls. The Seagulls want the chips, the commission, and over results the fund managers hand out a lot of chips, it is a time they make a lot of decisions about whether to buy or sell a stock, and the research is the broker’s way of saying “Mine”, “Mine”. And so it was that ten pieces of Westpac research landed on the broker’s desks this week.
Most of it was standard stuff. For the major banks at the moment that means an unenthusiastic regurgitation of the results and the now standard “Hold” recommendation with a target price a few per cent above or below the current share price. But for Westpac, this week, there were a couple of stand-outs.
One major broker had an ‘ADD’ recommendation and a target price of 3300c which was 22% above the current share price at the time. Meanwhile, a second major broker had a SELL recommendation and a target price of 2200c which was 18.7% below the current share price. How could two professional analysts working off the same data on a highly researched company with predictable earnings see one with a target price 50% above the other?
Perhaps we should put these two analysts in a room and have them explain it. It would make a good TV show, seeing why, despite the apparent credibility of the institutions they work for, the salaries they get paid, the qualifications they have, their access to information and their privileged relationships with the companies that they analyse, why, they manage to disagree on valuation by such a wide margin on such an ‘easy’ to analyse company.
I get regular emails about the illogical nature of broker recommendations. The most common complaint asks why a broker has a sell or hold recommendation when their target price is materially above the share price, or a buy recommendation when the target price is materially below the current share price. Private investors expecting broker research to be logical. Hilarious.
The disparity in the Westpac target prices lifts the lid. Research is not a science. If it were valuations would be correct at all times and share prices would not move. Who wants that? No-one who lives off commission. It is disagreement that fuels stock market activity, not consensus, and activity is the lifeblood of the investment industry. You may look for certainty as an investor but it is not in the industry’s interest to provide it, even if they could. They want activity, volatility and opportunity, not agreement, stagnation and understanding.
So excuse the brokers if they can’t agree. This is a game of “Mine”, of “Get the chips”, it is a game of commission and corporate deals and he who squawks loudest with the most eye-catching opinion wins, and rather than dismiss the Westpac outliers the other brokers should be kicking themselves that they were not so bold. No-one stands out in the middle.
The harsh reality with research is that it is written to generate business not written to help you, the private investor, make money.
Very little research is truly independent of motive. The motive with Westpac is to grab the largest share of the chips, of the commission available around the results, by getting the fund managers to deal in the stock, and you don’t get the chips by saying “Hold” with a target price in line with current share price. Do that and you might just as well not bother writing anything at all, because no-one will notice you and the chips will go to the somewhat smarter Seagulls, the ones that are making a noise.
The motivation behind broker recommendations is to do business with the big fund managers or the companies themselves. So “Buy” means “give me an order” or “we hope the company gives us a corporate deal”, and “Sell” means “give me an order” or “I have given up any hope of ever getting a deal off this company”.
Research is not aimed at you, your bag of chips is, unfortunately, a bit too small for the big Seagulls to care about. So take it all with a pinch of salt, it is not a science it is a mixture of art, marketing and begging for business. It is always worth reading but it is never to be slavishly obeyed. But you knew that already…didn’t you?