And You Thought Our Stock Ratings System Was Screwed Up

In the February 8^th Sunday New York Times, the Business section contained an article entitled “Why Analysts Keep Telling Investors to Buy”.  It’s worth a read, even if it covers familiar ground to those experienced in the ways of Wall Street and investment analysts.  The long and the short of the article is that even in the mist of a terrible bear market, analysts still only have sell ratings on 5.9% of all stocks.  Having missed all of the warning signs for the current economic downturn, most analysts are now of the opinion that stock prices are so low that now is the time to buy.  Nobody wants to issue a sell rating just when the markets turn up.

I’ve written about this phenomenon before (see “Stock Ratings from Lake Wobegone”, May 15, 2008).  Leaving aside the tendency of the stock market to rise over time, all of the incentives on Wall Street favor the optimistic, bullish view.  When an analyst issues a sell rating, companies hate him, investment bankers hate him and commission flow goes elsewhere.  The only ones who like sell ratings are short sellers, and they are often viewed as the pariahs of the industry, commonly blamed for all sorts of financial misdeeds and shenanigans.  (My own feeling is that short sellers, like jackals and hyenas, form a natural part of the ecosystem, but that doesn’t mean we have to like them.)

None of this would be worthy of a lot of additional comment on my part, except that about the same time as I read The New York Times article, I also ran across a brief piece in the February 7^th issue of The Economist magazine that made me think that maybe, as skewed as things are here, they’re a lot better than some other markets.  The article, entitled “Bye bye sell” takes a look at research recommendations in the South Korean and Taiwan markets.  In both markets it appears that government regulators actively discourage brokerage firms from issuing critical research.  In South Korea, the Financial Supervisory Service has been known to investigate brokerage firms that issue critical research, while in Taiwan, if the press quotes critical research, the government requests brokers to provide “explanations” as the press is required to receive a securities firm’s approval before quoting research.

The results are predictable, as the research firms quickly learn that critical research brings more trouble than it’s worth.  For example, during 2008, there were 17,335 research reports issued in South Korea, and not a single one was a sell recommendation.  This is not what you think of when you start talking about efficient markets.  As bad as our distribution of stock recommendations is in the U. S. we are not burdened by a government bureaucracy that views stock markets as an instrument of optimistic government policy. Yet.  

Investor Relations Year in Review

Like Jimmy Buffet, I sat down last weekend just to try and recall the whole year; all of the faces and all of the places, wondering where they all disappeared. Unfortunately, unlike Jimmy, I didn’t run into a chum with a bottle of rum, so I wound up sitting right here. Writing this post, I may add. Herewith a quick review of some of the more notable things I noticed in the world of investor relations this year coupled with Palizza’s Predictions for 2008:

The World is Going Electronic: The SEC ushered in the era of more aggressive electronic delivery of proxy materials in 2007. Previously, shareholders could opt-in for electronic delivery of the proxy statement and annual report. Relatively few did. Now, companies can force them to opt out of electronic delivery. The first big annual report season for this new delivery method will occur in the Spring of 2008, and given the cost savings in printing and postage involved, most companies will make economically rational decisions and force shareholders to take action if they want to receive a paper copy of the annual report. After all, investor relations reports to the CFO, not marketing. Annual report printers everywhere have to be very concerned about the disappearance of the traditional printed annual report. Companies will like the cost savings and designers of annual reports should be neutral on the subject.

Hedge Funds and Activist Investors have a Bifurcated Year. The first half of the year saw lots of activity by hedge funds and activist investors. Deals were easy to come by and the credit markets were loose. Company managements were always looking over their shoulders to see who was sniffing around. All of this came to a screeching halt in the second half of the year as the sub-prime mortgage crisis caused the credit markets to lock up. Companies that have been underperforming or that are particularly subject to financial engineering because they have underleveraged balance sheets have gained a bit of breathing room. If they’re lucky, investor relations officers will be able to focus more on the longer term fundamentals and less on the short term trading trends in 2008.

A Corollary to the Credit Crunch: Look for the M & A pendulum to swing back in favor of strategic corporate purchasers over the next year or two, until the credit hangover eases. Of course, corporate purchasers will have to try and overcome the heightened price expectation of sellers who have seen the multiples financial buyers paid over the past few years. That should make for some interesting investor relations spiels from IROs as they attempt to justify the price being paid.

The U.S. Dollar weakened throughout the year against the British Pound and the Euro. U.S. equities must look like relative bargains to investors in Europe. On the other hand, whatever gains European investors had in U.S. equities this year were probably wiped out by currency conversions back into the Pound or the Euro. (The market giveth, and the market taketh away.) Look for more interest in U.S. equities from European investors in 2008 provided they start to think the U.S. dollar is at or near the end of its slide.

Four predictions is about all I can handle, so I will close out with best wishes for a happy holiday season for all and a prosperous new year. May the markets be kind to you in 2008!

What the World Equity Markets are Telling the U. S.

Last week I conducted a workshop on investor relations in Singapore for Asian companies. It has underscored for me the fact that we live in an increasingly global village. Yes, there are cultural differences. There are also time and distance differences that sometimes make communication difficult, but the process of transferring information from companies to investors seems to be remarkably similar worldwide.

We now have publicly listed companies in spots such as China and Vietnam. These are economies that did not even acknowledge the benefits of capitalism just a short time ago. I don’t know why, but it came as a revelation to me that companies in these countries worry about much the same things that investor relations officers do here in the U. S. – being undervalued relative to their peers and the index, managements that expect everyone to love their stock, how to measure the effectiveness of IR, and hedge funds, to name a few topics. There are differences – some of the companies I spoke with had relatively low levels of public float and a number of markets were heavily influenced by speculative individual investors, leading to volatile stock price movements. My impression, however, was that many of the differences related to the equity markets being younger, and that as the markets mature and deepen, with greater levels of liquidity and professional investors, most of the differences will work themselves out of the market.

One fact came through loud and clear however – none of the companies I spoke with were listed on a U. S. exchange, and further, none of them had any remote desire to list in the U. S. The reason universally cited was Sarbanes – Oxley. None of the companies wanted to voluntarily undertake the regulatory burden imposed by the legislation. Not so long ago, it used to be that listing in the U. S. was a sign that a company had truly arrived. Today, there are growing alternatives to the U. S. markets, including Hong Kong and London, which have more attractive regulatory environments. According to the Wall Street Journal last week, more IPOs have been filed this year in London than in the U.S. (although the U.S. is slightly ahead in dollar volume of deals).

I’m not in favor of a regulatory race to the bottom, but if seems to me that the U. S. has priced itself out of the equity listings market through the increased cost of compliance with our regulations. Clearly, the rest of the world is telling us that the increased security achieved through the oversight and controls required by Sarbanes – Oxley does not justify the increased cost. To put it another way, there would have to be a tangible benefit, shown by a premium to stock valuations for companies subject to Sarbanes - Oxley in order to justify the increased cost of complying with the regulations. Companies are not seeing it, and are taking their listings elsewhere. If the U.S. intends to remain a leader in the world equity markets, it needs to take a hard look at Sarbanes – Oxley.