To say there is a distinct buy-side bias in the brokerage community is an understatement. Brokers and analysts rarely recommend selling a stock. At least not in so many words. But broker analysts do use buzzwords that, to the trained ear, clearly spell out "Sell".
On May 22, 2002, Merrill Lynch, the huge Wall Street brokerage firm, agreed to pay US$100 million in penalties to forestall criminal charges in allegations of breach of trust and fiduciary responsibility by the company.
The company had been under investigation by New York state Attorney General Eliot Spitzer for alleged conflict of interest between Merrill Lynch’s analysts, who promoted stock issues to the public, and the company’s investment-banking arm, which handled lucrative new stock issues.
It came out that analysts who wrote glowing reports on stocks being handled by the investment-banking arm often disparaged these stocks privately, sometimes even going so far as to call them “a piece of crap.”
One such analyst was Henry Blodgett who quietly accepted a multi-million dollar golden parachute to leave Merrill. Blodgett became an Internet guru and one of the highest paid analysts on Wall Street during the dot-com frenzy. And true to form for many analysts, he just couldn’t say the word “sell.”
His sorry record? In January 2001, of 107 Internet stocks Blodgett had touted, only one had gone up. One! The second-best stock in the bunch was down 30 percent. As one wag put it, “An orangutan throwing a dart at a stock page would have done far better.”
At the time he still wouldn’t issue a sell order on any of them. The closest he came was a “near-term neutral” call on eToys just prior to its total collapse into penny stock status. Blodgett is hardly the only offender. There is a general tendency in Wall Street analyst circles to disdain the “S” word.
Morgan Stanley Dean Witter analyst Mary Meeker, who pulled in US$15 million in 2000 as an Internet guru, remained bullish in January 2001 despite her 11 Internet stock recommendations being down an average of 83 percent from their highs.
But it's not just Internet stocks. Analysts and brokers tend to be biased against selling. Why? Because recommending selling is tantamount to admitting you made a mistake recommending the stock in the first place. And so analyst brokers have developed a whole lexicon of buzzwords that mean "sell", even though they seemingly mean something else.
In his book It's When You Sell That Counts, Donald Cassidy, a senior analyst with Lipper Analytical Services, says that all of the following analyst buzzwords should be interpreted as "sell."
And the most dangerous word here, he argues, is hold. "In fact, hold,” he says, “really should generally be interpreted as meaning do not hold."
This interpretation is used by Mark Hulbert in his analysis of market newsletters. The Hulbert Financial Digest tries to rate and compare an extensive collection of investment newsletters applying uniform criteria to each. One of these criteria is that hold be interpreted as sell.
This has ruffled the feathers of some newsletter writers like James Dines, who still likes to write nasty remarks about Hulbert periodically in The Dines Letter. But as Hulbert explains his rationale, when managing a newsletter's recommended portfolio, he does not sell into a vacuum. He uses the proceeds from the sold "hold" stock to purchase stocks the newsletter writer rates as "buy". Surely a "buy" recommendation is stronger than a "hold" recommendation and the newsletter writer expects the "buy" recommendation to perform better than the "hold" recommendation, otherwise he would maintain a "buy" recommendation on the stock.
So we have another stock selling strategy - sell when brokers and analysts downgrade their recommendations to one of their euphemisms for "sell".
You should be cautious when a stock is downgraded even if a buzzword for "sell" is not used. A downgrade from strong buy to buy, or from top pick to outperform, or a cut in the target price, still seems to be a positive recommendation. But it is also a downgrade, which does not bode well for the stock. Such a stock should be monitored for further downgrades if not sold right away.
Downside to Selling on Broker/Analyst Euphemisms for Sell
The big hazard to selling on a broker/analyst downgrade is that the broker/analyst could be wrong. As our examples of Blodget and Meeker above show, they often are - and in spades. So they could just as easily err on the downside as the upside. Nevertheless, given the industry reluctance to issue a sell recommendation, a sell euphemism is a fairly strong indicator that they are reluctantly backtracking or have knowledge that there is a serious problem.
Summary of Advantages and Disadvantages
Note: Parts of this section were reprinted from my book, 50 Best Science & Technology Stocks for Canadians
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