Pittsburgh Post-Gazette
Penn State Professor Casts Doubt On Usefulness Of Analysts

By Len Boselovic

As if New York Attorney General Eliot L. Spitzer hasn't done enough to expose their lies, deceit and conflicted interests, now a Penn State academician is questioning the competency of Wall Street analysts.

J. Randall Woolridge, a finance professor at the school's Smeal College of Business, began his intellectual journey with a simple question: How much money can investors make by listening to analysts when they recommend stocks?

"We all know these analysts are bright people. They're close to the market. They do this all the time," Woolridge said.

Theoretically, the fact that analysts eat, drink and sleep stocks should make them pretty good when it comes to distinguishing between winners and losers. Spitzer has proven beyond a shadow of doubt that, in the real world, those theoretical skills and advantages can be irrelevant. At Merrill Lynch, reports of Internet companies written by Henry Blodget didn't square with the defrocked analyst's private assessments, which relied on "a piece of junk," "dog" and other blunt descriptions when talking about companies he was publicly recommending.

Woolridge didn't study how analysts reached their conclusions. He focused on whether investors were well served by their recommendations. On average, they weren't.

The professor studied the performance of stocks recommended by brokerage firms from 1993 through 2002. On average, the quarterly and cumulative returns on analyst picks fell just short of returns on the Standard & Poor's 500 index. Moreover, investors who bought analyst picks took on slightly more risk than those who put their money in the S&P 500 and forgot about it.

Compounded quarterly, the analyst recommendations earned 2.17 percent on average vs. 2.26 percent for the S&P 500, Woolridge says. Investors who made a 10-year bet of $1,000 on the analyst picks and reinvested the dividends would have had $2,359 at the end of 2002 vs. $2,443 for the no-muss, no-fuss investor who parked $1,000 in the S&P 500.

Woolridge also discovered that analysts at mid-tier and small brokerage firms outperformed their colleagues at major Wall Street firms that have major investment banking operations. Those operations can taint the opinions of analysts, making them recommend stocks of companies that use their investment bankers to sell stocks and perform other services.

The average returns of the midsize and regional firms were virtually identical to the returns on the S&P 500. Large brokerages provided an average quarterly return of 2.04 percent. Placing a $1,000 bet on their picks would have rewarded investors with $2,241 after 10 years vs. the $2,443 generated by the S&P 500.

While the difference in returns is small, Woolridge says it raises the issue of whether reading analyst reports is time well spent.

"Today on CNBC, you'll see 15 analysts making recommendations. Well, you ought to look at them pretty carefully because, on average, they don't do very well," he said.

Some brokerage firms did much better than others. Notwithstanding Blodget's antics or the fact that his firm shelled out $100 million to settle Spitzer's charges, Woolridge discovered that investors would have made the most money buying the recommendations of Merrill Lynch analysts. Those picks provided an average quarterly return of 3.07 percent, enough to turn $1,000 invested at the beginning of 1993 into $3,346 a decade later. Compare that with the paltry 1 percent average quarterly return produced by Lehman Bros.' brain trust, which converted $1,000 into $1,487.

"I had no idea who would win this. The fact that Merrill did kind of surprised me," Woolridge said.

Copyright 2003 P.G. Publishing Co.

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REPORTERS & EDITORS: For more information, please contact Wyatt DuBois in the Smeal College of Business Media Relations Office at 814-863-3798 or wed112@psu.edu .

Penn State's Smeal College of Business offers highly ranked undergraduate, MBA, executive MBA, Ph.D., and executive education opportunities to more than 5,500 students at all levels. Featuring academic departments of accounting, finance, marketing, insurance and real estate, management, and supply chain and information systems, the college is also home to major research centers such as the Center for Supply Chain Research, the Institute for the Study of Business Markets, the eBusiness Research Center, the Farrell Center for Corporate Innovation and Entrepreneurship, the Center for Global Business Studies, and the Center for the Management of Technological and Organizational Change.

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