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Friday, May 04, 2007


Having been the catalyst that sparked Wall Street’s $1.4 billion settlement for conflicted research, the quality and accuracy of the Street’s equity coverage is understandably a subject near and dear to my heart. That’s why I nearly choked on my morning breakfast earlier this week when I read the following comment by Andy Kessler, a former Wall Street telecom analyst, about a Banc of America Securities analyst who had the temerity to initiate coverage on about a half dozen pharmaceutical stocks without talking to management.

Initiating coverage without speaking to management "is absolutely pointless for a money manager," Kessler opined to the New York Post.

I beg to disagree.

Disgraced analysts Jack Grubman and Henry Blodget were "tight" with the managements they covered, and we all know about the quality of their work. A more recent example is some divergent coverage on Circuit City, the once darling stock that has imploded.

An obscure research outfit called Rate Financials, which maintains a strict policy of not talking to management, warned investors about the perils of investing in Circuit City nearly 10 months ago. Meanwhile, two prominent retail analysts, Gary Balter of CSFB and "independent" analyst Dana Telsey, were touting the stock. Balter and Telsey apparently had close ties to –and apparently were blinded by -- Circuit City’s management.

Here are the facts I’ve garnered based on published news reports and some of my own research:

Rate Financials last July issued a critical report on electronics retailer Circuit City (NYSE:CC), claiming the company wasn't properly accounting for lease obligations and that earnings were generated almost entirely from the sale of extended warrantees and not from profits earned on peddling electronics. At the time, Circuit City was trading at around $26 a share.

Balter, who in September had an "outperform" rating and a $35 price target on Circuit City shares, didn’t take kindly to Rate Financials’ report after it was highlighted in a September article in the Wall Street Journal. Balter issued a critical report on Rate Financials’ analysis that included this admonition: "Circuit City stock rose 54% in 2004 and 44% in 2005. Which side of the trade would you want the sell side to be on?"

Telsey’s affection for Circuit City was disclosed in a December 14, 2006 article in Fortune magazine, where she included the retailer as being among the nine companies showing "the most near-term promise" of the 38 retailers she covers. Interestingly, Telsey on her website trumpets that she is in "front of the executive management of the most influential companies," and that she speaks "directly with the sales associates in the stores." Telsey told Fortune she had a $30 to $32 price target on Circuit City.

Investors who heeded Rate Financials’ warning fared well. Circuit City last month, announced significant decreases in earnings estimates, fired its CFO, and terminated its most experienced sales staff (presumably the staff Telsey was talking to). And guess what? Contributing to the loss were decreases in warranty sales and lease obligations. Circuit City dropped a second shoe earlier this week by announcing yet another profit warning.

Circuit City now trades at around $16 and change. Balter has cut his rating on the stock to "neutral" from outperform and now has an $18 price target. No public word on Telsey’s view on the stock.

Here are some other interesting facts worth noting.

  • Rate Financials apparently isn’t a one-trick pony. In August of 2005, Calpine Corp. issued a special press release denouncing a Rate Financial’s report calling into question its accounting procedures. By December, Calpine had declared Bankruptcy.

  • Fortune readers who acted on Telsey’s stock recommendations haven’t fared too well. Her basket of recommended stocks are up 3.3 percent since the article was published, while the S&P Retail Index is up 4.3 percent. Perhaps Telsey should spend a little less time talking to managements and sales clerks and learn how to read the fine print in publicly disclosed documents.

Sadly, Rate Financials research is costly and beyond the reach of individual investors, providing another case in point as to why the markets are stacked against them.


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