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Wall Street Learns How To Say "Sell"

By Rob WalkerPosted Wednesday, Jan. 9, 2002, at 1:19 PM ET

It's been observed many times that Wall Street analysts hardly ever issue "sell" recommendations. It's even more unusual for them to use that blunt term in connection with a company that 1) you've heard of; and 2) hasn't already flamed out. (A.G. Edwards and Prudential, for example, issued sell ratings on Enron in October and November when its stock was already deep into free fall.) So, it's worth noting that in the past week or so, two major corporations have been hit with sell ratings—Kmart and Conseco. Does this indicate the dawn of a new frankness on Wall Street? Not really. But it's still interesting.

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First let's review terms. As I've mentioned before, the buy-sell-hold model doesn't really mean anything as straightforward as what those words imply, and in fact it's gradually been replaced at many firms by more complicated sets of terms that offer analysts even more cover when things go wrong. So, more often than not, a "sell" rating means something like "this company's share price has already collapsed and shows no sign of recovery" or possibly "this obscure company's prospects are so suspect that no one should consider buying stock in it." (On the latter score, most analysts simply don't bother to acknowledge the existence of such firms.)

Both Kmart and Conseco had seen extremely steep share-price declines already. Conseco had sunk from a high of about $58 in 1998 to around $4.25 by the time it got hit with a sell on Jan. 4. Kmart, which had traded as high as the low 20s in 1998, was already down to around $5.50 when the sell judgment arrived Jan. 2.

Kmart's sell rating came from an analyst at Prudential. The discount retailer had already announced that it was finishing the year below plan and that it had failed to benefit from the last-minute surge in Christmas shopping that helped rivals like Wal-Mart. This was followed by negative rumblings from the ratings agencies that try to assess a company's ability to pay its debts. And finally came the Prudential report, which included the gloomy statement that, "We would not be surprised if the company were to file Chapter 11 bankruptcy if trends do not improve." Kmart, of course, quickly responded that it has plenty of cash and credit lines to stay in business and turn the corner back to profitability.

In the case of Conseco (an insurance and consumer-lending company) it was an analyst at Salomon Smith Barney who issued the sell signal—or to use Salomon's lexicon, the "avoid" signal. His main concern was the possibility of Conseco's snowballing loan losses. The company called his logic "absurd."

Again, you might think that it would be more useful for an analyst to recommend that shareholders sell sometime before a stock had lost 70 percent to 90 percent of its value. But as these things go, both of these sell calls are actually unusually bold. That's because the markets had not yet concluded that either company is completely hopeless—usually a precondition for a sell rating. Shares in both firms have sold off a bit since the negative ratings, but Kmart still has a market cap of more than $2 billion, and Conseco's is over $1 billion. If either firm makes a comeback, those sell ratings will turn out to have coincided with great buying opportunities, and the bearish analysts run at least some risk of being embarrassed. That alone is pretty rare.

Of course, all of this arguably says less about the intrinsic boldness of these sell recommendations than about the complete lack of boldness that prevails on Wall Street most of the time. A little progress is better than none, but when it comes to taking a controversial stand in their stock ratings, analysts remain profoundly risk-averse.

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COMMENTS

I work as a financial analyst for a living, and firsthand knowledge tells me that unless an analyst specifically made a recommendation for you, it is practically worthless.

90% of analyst recommendations are not even meant to be followed by the general public, and are meant for institutional investors, especially mutual fund managers. Why is that important? Because mutual fund managers have very little control over the timing of their trades, and instead just have to raise or invest cash at the whims of their investors. So instead of "finding a good deal right now", they have to look at analysis that is broader in nature and meant to be longer-term and big picture.

Furthermore, an analyst-recommended stock still is not automatically a good choice, whether you are an individual or an institution. It depends on how it fits into your portfolio of investments, and whether you need a stock with a particular risk-reward profile, and how long you will hold the stock (what your asset turnover ratio is) and a hundred other factors that the analyst has no idea about because he doesn't even know you exist.

"Buy", "Hold", and "Sell" mean this: Take a look at this stock, carefully evaluate it in comparison to the rest of your holdings, and consider modifying your holdings to accommodate what I think about this stock/company, if this investment makes sense for you and your individual investing goals. But please continue to think for yourself and don't put me in the driver's seat. Don't worship me when the stock goes up, and don't blame me if you lose your shirt.

--mfbenson

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I haven't tried to keep up with the recent spin on CNC, but a couple years ago, CNC was a favorite among short sellers. Then CNC brought in a new CEO from GE, and they shed an albatross division, and the stock nearly quadrupled based on an improved outlook and some forced liquidations of short positions. I'd not be surprised if the "sell" recommendation isn't playing to short sellers on a stock with a history of down-side speculation.

Personally, I suspect there is a much better chance you could treble your funds in the stock at current valuation on the buy side than by shorting. Stated book value for the stock remains about 2x current equity valuation. So, in a sense, the analyst has stuck their neck out, but the level of risk for the analyst in terms of generating business might not equate with potential for profits by either selling or buying the stock

--Charlie Heath

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