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Decoding Wall Street’s Well-Kept Secrets

This chapter is from the book
By decoding the confusing, cryptic Wall Street practices, you can unlock the handcuffs that inhibit superior investing. If you understand the research game to the same degree that professional portfolio managers do, the playing field will be more even.

As a securities analyst for 32 years, I am amazed that naive investors can be so misled by Wall Street doubletalk. You can be an astute investor only if you fathom the puzzling and often deceptive nature of the Street. Do what Wall Street does, not what it says. Don’t take the Street literally. Wall Street operates in strange, ambiguous ways that it would prefer to keep secret. Its research cannot be trusted. The individual investor is an afterthought, mostly neglected by analysts and brokerage research departments. Analysts’ opinions change and their statements move stocks. The media passes along analyst commentary and prints their views. Corporate executives react to Street sentiment, and attempt to influence their stock prices. Wall Street cannot be ignored. By decoding the confusing, cryptic Wall Street practices, you can unlock the handcuffs that inhibit superior investing. If you understand the research game to the same degree that professional portfolio managers do, the playing field will be more even.

In mid-1985, I decided to take a new job on Wall Street and make a shift to Merrill Lynch, but I had to sit tight for 10 days. I was scheduled as Louis Rukeyser’s guest under the Salomon Brothers moniker and couldn’t resign gracefully until off the set of Wall Street Week. I already felt edgy on arrival in the remote horse country of Owings Mills, Maryland. After cooling my heels a couple hours in the studio, Lou, who hadn’t finished writing his commentary, wasn’t ready to tape the show at the normal time that Friday evening, an hour before it aired on PBS. So my appearance was one of his infrequent programs that went on live—adding pressure and more time to stew. Seated just off the set for the first half of the program with a pitcher of water, I was told to be still or the viewers might see the movement of my shadow. Nervously, I consumed most of the jug and badly needed relief about the time the hostess grabbed my arm to strut me out to the couch in front of the cameras and panelists. My bladder bulged as the hostess whispered to me and we wheeled into camera view, “Don’t trip on the platform, three million viewers are watching.” I sank down into the gigantic soft sofa, feeling like a midget looking up at Rukeyser, who towered over me in his high-perched chair. All my hours of practiced answers flew out of my head. I was babbling. It was like truth serum, but I survived. Analysts like me are not accustomed to being grilled. We normally have the upper hand. At least we’re good at faking aplomb and we rarely come unraveled. This book puts you in Rukeyser’s shoes. It’s intended to unravel Wall Street security analysts and their research.

What is a Wall Street Securities Analyst?

To comprehend Street research, you must first be familiar with the function of a securities analyst. I am talking about an analyst at a brokerage firm investment bank, not an in-house stock analyst at mutual funds, banks, or investment management firms that cater only to the portfolio managers within their own firm. The job function of brokerage analysts is to conduct research on companies and industries and “sell” it to the brokerage institutional clients and secondarily to individual investors. A typical Street analyst heads a small team of associates, is situated in New York (I was in New York for 20 years and then relocated to San Francisco for the last twelve years of my career), has maybe a dozen years experience, and is in the 30 to 40 age range. The ideal analyst has an MBA degree, should be a Chartered Financial Analyst (CFA), is adept at reading and interpreting financial statements, understanding and building complicated mathematical earnings models on a computer, writing research reports, talking and interviewing, and selling/marketing. This is a wish list, as rarely do analysts have all these qualifications.

The primary requisite of any analyst is to be an expert on a particular industry sector and group of companies therein. There are analysts covering areas such as high-tech semiconductors or software, retail specialty stores, the oil and gas industry, biotech, airlines, utilities, and banks. I began covering the entire computer industry in the 1970s when it was small, gravitated to focusing on software and computer services in the 1980s, and then covered only computer services starting in the 1990s (companies like EDS, Automatic Data Processing, and Accenture). Analysts conduct research on and rigorously track a limited number of companies in their chosen industry area. They must understand the dynamics, influences, and underpinnings of the industry, and be exceptionally familiar with as much detail on each company as possible—elements like the financials, products, competitive position, management, strategies, and research and development. Analysts must have an ability to judge executives, assess the impact or effect of any number of influences on a company, have the vision to see the big picture amidst tumultuous current pressures on a stock, and analyze a company’s outlook with incomplete information in an unclear situation.

It is common for analysts to have worked in the industry they are covering before starting on Wall Street. Analyst industry expertise is more important than a background in securities, investment or finance. I became savvy on the computer industry while employed at the U.S. Department of Commerce tracking the sector there. Wall Street recognized my knowledge of that area and hired me for that reason, not because of my MBA degree.

The next analyst qualification is an understanding of the stock market, investment, and securities (stocks, bonds, options, convertibles, etc.). This is basic stuff, things like listed vs. NASDAQ-traded securities, bid and ask spreads, stock buybacks, dividends, share issuances, stock options, debt (bonds), and all the mechanical aspects of the stock market. Sometimes this is obtained while earning an MBA degree or on the job, in the business, as a junior start-up analyst; and it is enhanced in the process of acquiring the professional CFA designation. I did both, but was further ahead of the game due to my college summer job at a small brokerage firm in Chicago, reading financial newspapers/magazines and books, investing on my own, and following the market for years before I landed on Wall Street.

Street analysts also need to have some grasp on the economy. My undergraduate degree was in economics. Several economic factors impact stocks and company fundamentals. Analysts should be conversant with elements like interest rates, employment, GDP, inflation, recessions, government spending and borrowing, foreign currencies, and international trade. An MBA degree is a key source to absorb background in economic disciplines.

The securities analyst’s role is to determine the industry and individual company outlook in the sector covered, conclude whether the stocks are attractive investments (a Buy opinion) or likely to perform poorly (a Sell), write up these findings in research reports, and monitor all this on a continuing basis. A key mission is to then verbally communicate this research to the brokerage firm’s institutional investor clients, and other key audiences like the in-house sales force and traders, and the outside media. Analysts on Wall Street must sell their research, that is, market their product and views. Notice I left out retail individual investors. Analysts don’t deal with them directly. To be proficient at this so-called marketing, analysts must be outgoing. No shy types. They make presentations to single portfolio managers or a room full of institutional investors. Analysts have to be convincing on the telephone or over their firm’s squawk box. They must have conviction, be strong, opinionated, confident, and come across as cool, intelligent, and balanced, like a 747 airline pilot during a turbulent thunderstorm (my worst nightmare). This requires personality, character, charm, and the need to be colorful and engaging. (Of course, I was all that and more—did I mention humility?)

The brokerage institutional salespeople caters directly to the portfolio managers, traders, and analysts at the firm’s institutional clients—mutual funds, hedge funds, pension funds, banks, and other financial institutions. They constantly, all day long, carry the analyst’s research message to these institutions, in person, on the phone, or by email. Salesmen may cover a half dozen such institutions and talk with perhaps five or ten key contacts at each one. They also help sell to these big clients initial public offerings (IPOs) and secondary share issuances their firms are underwriting, and set up meetings between their analysts or corporate executives and these institutional customers. Traders execute sizeable buy and sell orders on behalf of major clients and attempt to make money for the brokerage firm’s own account by trading stocks. Investment bankers deal with corporations, governments, and other entities in need of such financial services as selling stock or bonds, doing mergers and acquisitions, and structuring complicated financial/investment transactions.

What’s a typical day in the life of an analyst? During the latter portion of my career I was located in San Francisco, where the stock market opens at 6:30 AM, so my hours were on the early side. My firm’s morning conference call, where research analysts present pertinent new views or updates, commenced at 4:15 AM. I rolled out of bed at 4:10 AM, tossed on my sweats, and jumped on the horn. As this live broadcast was to hundreds of offices worldwide, it was critical to not fall asleep or screw up. Then, after donning slacks and a sweater, I drove through dark streets, grabbed a giant coffee, cream and sugar, and was at my desk by 6 AM. Things were now happening full blast as it was 9 AM in New York. The sales force was on my case to call key institutional clients to add color to the comments I made on the earlier morning call. My stock screen was racing with price changes, news stories, and other information in my face. Emails by the dozens pleaded for responses, opinions, scheduling, and all sorts of other matters. My team was in the office, wanting to chat or discuss research. No help from my administrative assistant, who waltzed in at about 7:30 AM, and worked fairly normal hours. At some point, I hustled a couple blocks over to a local hotel for a breakfast meeting with a mutual fund portfolio manager.

Back in the office around 9. The Wall Street Journal called. An executive from a company I covered was in town and showed up at my door mid-morning. We discussed his firm’s business outlook for an hour. My 16-ounce takeout coffee got cold, but I was still sipping it. I had to scrutinize, in advance, a detailed computer earnings model of a company that would report its results at 1 PM this particular day, after the market closed. Soup at my desk for lunch, the first thing I’d eaten all day. The earnings results hit the tape. We did instant analysis, prepared questions, and tuned in on the company’s 2 PM investor conference call. It was over at 3, and after a few minutes of pondering and quick analysis, I ground out a research report. Maybe about 5:30 I waved goodbye to the garage attendants, who gave me no credit since I didn’t top a 12-hour day. Alongside me in the front car seat was a portfolio of material to review during the evening with a bowl of ice cream and the baseball game quietly on TV in the background.

Abnormal events in the day of an analyst are normal. I was summoned to a payphone while atop the High Sierras in Yosemite by H. Ross Perot (the other campers were impressed) and was detained by passport control officers at an Italian border crossing the night Aldo Moro was assassinated. I have broadcast my research comments over the squawk box system from aircraft carriers and jumped on the box from phone booths in Vienna cafes. Sometimes I took advantage of the firm’s Chicago Cubs Wrigley Field courtesy suite up behind home plate, squeezing in an occasional night game where I had misspent the bulk of my youth in the bleachers. I’ve witnessed Michael Jordan in the NBA playoffs, gate crashed the Cannes Film Festival, bumped into Queen Elizabeth exiting a London theatre, sipped cocktails at Raffles bar in Singapore, and basked on Waikiki Beach. But there are dodgy scenarios too. Our Kansas City car service driver that I had used for years on client visits there turned up as a fugitive when the police found multiple homicide victims in his home. This mild mannered chauffeur was on the phone with our Chicago sales desk apologizing that he wasn’t available for the next assignment, while law enforcement was in pursuit. He was later apprehended, convicted, and given five life sentences.

And then there was September 11th. Jenny Dugan, a junior analyst on my team and I were in New York to conduct a day of one-on-one meetings with investors. Two clients had requested the 8 AM lower Manhattan area time slot, Fred Alger Management and another bigger mutual fund, which ended up getting the nod. Jenny was meeting with the latter client in the World Trade Center tower at 8:50 AM, while I was uptown. The first plane hit one floor below the Fred Alger offices where our meeting would have been were it not for that other request. Tragically, no one at that firm survived. All of us in the business were deeply saddened by the events of that day as we all knew people who lost their lives. Jenny and her group found the stairwell overcrowded and exited via the elevator. To this day she is reticent to discuss it and has hidden away her WTC-2 security building pass issued that morning revealing her photograph and the September 11th date.

The greatest reward a securities analyst can obtain is being brilliantly correct on a major investment recommendation. I discovered Fiserv as an emerging stock early in the late 1980s, constantly pounded the table with a resounding Buy, and watched it rise steadily in price for more than a decade. A more established company, Computer Sciences, had been a lackluster performer for years when its prospects gradually started to improve. I was the earliest analyst on the Street to recognize the metamorphosis and my favorable opinion shift proved to be an insightful call. It was a winner for years. Conversely, the worst nightmare for an analyst is having a recommendation go wrong. All analysts vividly remember their bad picks.

The perks of an analyst’s job aren’t bad either. The best place on earth for golf is Augusta National in Georgia, the site of the Masters tournament. Even for Tiger Woods or Jack Nicklaus, that place is sacred. The ghosts of legends like Bobby Jones and Ben Hogan loom down the fairways. So you might imagine the awe that Augusta inspires in a mediocre duffer like myself. When the chairman of an Atlanta-based software firm, John Imlay, part owner of the Falcons NFL football team, inquired of my availability to take in a game from the owner’s box, loiter in the locker room, and chat with the coach on the field, I could barely get the yes word out of my stammering lips. And while that was rolling off my tongue, he mentioned as an aside that we’d also be motoring to Augusta afterwards for a couple days of golf there.

Magnolia Drive, the Butler cabin, dining in the clubhouse, each of the 18 holes that I was so familiar with from TV coverage—the entire venue was a dreamy, mystical ecstasy. Caddies handed us the golf club we were supposed to use, not the one we could hit best given our ability—normal people can’t hit a two-iron. I maxed out my credit card in the golf shop, was told “those green jackets on that rack are for members only,” swiped all the logo-ed stationery out of my room, and feigned a nonchalant demeanor the whole time. My game was atrocious. What do you expect playing on hallowed ground as if in the presence of Divinity? Well, you can see the outing was a highlight in my life, and it wasn’t a bad locale to chat up management.

The most trying aspect for security analysts on Wall Street is the insecure feeling of always being vulnerable to anything that might impact the stocks they cover. The fear stems from realizing that at anytime during a business day a company under coverage might announce dramatic surprising news. An analyst in this circumstance must scramble, jump on a conference call, respond to an avalanche of inquiries from the sales force and investors, and instantly assess the situation to form an accurate view. This is difficult enough if the analyst is in the office with all necessary resources at hand. It’s a disaster if it happens during a tightly packed all-day client meeting trip, while on an airline flight, vacationing on a cruise ship, or on the golf course. Analysts can never relax on days the stock market is open. Even on holiday in August we monitor our Blackberries and call in periodically every business day, just like a doctor on call.

Heavy travel is inherent in the investment analyst profession. Travel stories are legend. Seated in the last row on a flight from Seattle, I could see before take-off that the emergency exit door behind me was left ajar. Daylight was peering through the opening. Upon pointedly notifying the attendant, she phoned the flight deck but, without inspecting it, the pilots pronounced the hatch secure from the cockpit because there was no indicator light on. My seatbelt was strapped on like a tourniquet. I knew the outcome—we wouldn’t be airborne long without pressurization—and was flabbergasted by the crew’s attitude. One circle of the airport, and we were landing again. Bulky maintenance brutes tried slamming the hatch to force it tight. They were still banging away when I grabbed my carry-on baggage and bailed, my confidence shot. Several others followed. So much for aircraft structural integrity.

Twice I’ve been on a plane that was struck by lightning, a bright flash outside the window and a thunderous boom. Good for the nerves. I knew a fellow analyst at a different firm who was on the Pan Am 103 Lockerbie flight, blown out of the air by a terrorist bomb. Several of us attended the funeral. A little macabre, but with such extensive travel, analysts are exposed to risks. An associate’s flight from New York to San Francisco hit sudden turbulence, plummeted 10,000 feet, the service cart and attendants hit the ceiling, red was splattered all over the floor thought to be blood but later found to be red wine, and the plane made an emergency landing in Kansas City. After realizing the function and role of Wall Street investment analysts, you need the rest of the story. That’s what this book is all about—the reality and well-kept secrets of Street research. To be effective, investors need to comprehend how Wall Street operates, to work around it in some cases, and to take advantage of it in other situations. You will be able to invest on a par with the professionals once the strange, deceptive ways of Wall Street are demystified.

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