Evaluation Watchword Is 'Quality'
Byline: Lynn Strongin Dodds
"Back to basics" has become the new mantra in research departments this year. After the excesses of the boom years and the accountancy and financial disasters that followed, analysts are returning to their roots. Traditional share valuation measures such as dividend yield and cashflow are back in vogue. Quality, not quantity, is the watchword.One head of global research says: "During the bull market, research became superficial, with analysts acting as the mouthpieces for companies. There was little primary research being conducted. In fact, some notes were simply recycled company press releases.
"Part of it was due to time constraints and the other part was tied to investment banking and company pressure to put out favourable reports."
There was also a trend among the leading brokerage houses to produce weighty, highly technical industry tomes, especially during the height of the TMT bubble. Industry experts, not analysts, were often the authors, and the research focused more on the ins and outs of the technology being heralded rather than the investment opportunities in the sector.
Today, these reports are a luxury few can afford. Investors are no longer impressed and instead want thematic reports chock-full of objective, new and interesting money-making ideas.
Fund managers are also much more interested in old-fashioned number crunching. US and European regulators have turned up the heat, especially as many analysts were recommending troubled companies, such as Enron, and more recently WorldCom, at a time when the walls were crumbling around them. Rating systems have now been simplified and brokers are required to disclose their methodology.
Patricia Doran Walters, a senior vice-president of the Association of Investment Management and Research, says: "It is unrealistic to expect analysts under normal circumstances to detect fraud. If individuals want to commit fraud, they know how to hide it.
"However, this is not to say that analysts should not have seen the red flags. Analysts need to be more detail-oriented."
Nita Sanger, a partner at Freeman, a US-based strategic consultancy, says: "While few would have predicted WorldCom's $3.8bn (E3.9bn) accounting fraud, analysts should have been aware of the piles of debt it was accumulating. The signs were there.
"However, they might have continued publishing optimistic reports because they were afraid of risking the wrath of senior management and no one wanted that at the time. Now, analysts are going back to the balance sheet and being more much more conservative."
This explains why dividend yield, price earnings (p/e) ratio, net asset value and cashflow are firmly back in the analysts' vernacular when evaluating stocks.
Analysts are now questioning a company's high p/e ratio to assess whether it will have several years of unsustainable growth and whether it has enough cash to cover its dividends. Cash has become a particularly important measure because it is more difficult to manipulate than profit.
Research teams are also focusing less on earnings before interest, tax depreciation and amortisation (Ebitda), which became a popular measure in the US and UK, especially for telecoms companies. …