Monday, August 31, 2009

Grumpy Analyst Syndrome, or, “Optimistic, How Dare He!”


A hallmark of any major market rally—like the one we’ve had since the March give-up—is what we here at NotMakingThisUp call Grumpy Analyst Syndrome.

G.A.S. occurs when Wall Street’s Finest—who generally get around to throwing in the towel on their favorite stocks only at the tail end of whatever bear market we’ve just been through—miss the normal head-snapping rally that tends to follow the give-up phrase of that very same bear market they finally caved into.

Not that it’s easy to identify the actual give-up phase while it’s happening, mind you.

After all, so many head-fakes occur along the way that by the time the give-up comes it’s hard to focus on writing buy tickets while you’re you-know-what-ing your guts out and asking yourself “How,” in the words of the famously self-berating former New York Yankee Paul O’Neill, “could anyone be this bad???”

Of course, one excellent indicator of the give-up phase itself is the number of Wall Street analyst downgrades on stocks hitting their all-time lows. It’s a sign that enough of their clients have sold those very same stocks that Wall Street’s Finest finally feel comfortable downgrading the names without fear of backlash—which means things are getting sold out.

Thus it is that once the give-up passes and the rally begins, Wall Street’s Finest always—and we mean always—find themselves in the uncomfortable situation of having thrown in the towel at exactly the wrong moment.

What they do afterwards, naturally, is what any rational human being would do when the facts change: they acknowledge the new reality, re-evaluate their recently adopted negative stance, and change their rating back to “Buy.”

Just kidding!

What they really do is this: they get grumpy, and they look for bad news to support their recently adopted negative stance.

Now, for the record, we’re not speaking here as embittered, disillusioned clients of Wall Street’s Finest looking to get even.

Rather, we’re speaking as a former member of that club, one who made the same mistakes years ago that they’re still making today.

“Been there,” as the saying goes, “done that.”

Thus we believe we are well-qualified to report on one fine example of Grumpy Analyst Syndrome, which occured during last week’s Toll Brothers earnings call.

In this case, a particularly Grumpy Analyst actually told management—i.e. the guys who run the actual business and, presumably, see more clearly what is happening on a day-to-day basis than any outsider, let alone a Grumpy Analyst—that management was being too optimistic about its own business.

Here’s how the conversation all went down, as recorded by the indispensible StreetEvents, starting with the Grumpy Analyst. (
Note how the G.A. treads lightly before all the negative stuff starts to spill out, like Kyra Sedgwick working a suspected murder/rape/carjacking/identity thief on The Closer):

How are you guys? I -- looks like you -- you're feeling better, Bob, and realizing that your overall trends have shown improvement. I sense a little optimism with, I don't want to call it Kool-Aid, but a little concern about the increase in foreclosures at the higher end that are in process right now with option ARMs and Alt-A and overall foreclosures in process up about 90% today year-over-year and just wondering, you mentioned the talk of a double dip but there was certainly views that the high end has been showing activity with more jumbo as a percent of the mix in northern Cal, like you mentioned, Joel, but realistically a lot of those houses are trading at significantly lower than where they were purchased and consumers are under water and there is lots of concerns that are not playing out at the moment, but arguably could be major headwinds and I'm just wondering if your views of stabilization might be a little bit premature and how much risk do you think is out there and are you concerned at all as I am?

Now, unlike most of Wall Street's Finest who come down with Grumpy Analyst Syndrome—i.e. the ones who threw in the towel at exactly the wrong time—this particular Grumpy Analyst had the foresight to jump off the Housing Train before it went clear off the tracks several years ago, t
hus allowing those clients who took her advice to survive most of the carnage.

Unfortunately, however, she then stayed grumpy while most of the homebuilding stocks more or less doubled off their give-up lows.

As always, we offer no opinion on the value of homebuilding stocks. Indeed, they may well be sells at these levels—mathematically speaking, at least, there is half the value in the building stocks that have doubled from their lows.

But in looking at the business itself—as opposed to near-term stock moves—we’d take Bob Toll’s view of the world over somebody with Grumpy Analyst Syndrome.

And after a couple of years of being downright grim, he’s a lot less grumpy than most of that segment of Wall Street’s Finest who make homebuilders their specialty:

I am concerned, probably not as much as you are. There is no doubt the stats are what they are and they are ominous with respect to the increase in foreclosures for prime borrowers and for some of what used to be the higher priced product. Logically you've got to be concerned as to what the impact of that is on our new home -- our new home luxury home market, but in the face of these stats, at the same time, we see increased demand and that makes us feel a whole lot better.

This reasonable response, however, did not mollify our G.A., for she continued in the scolding vein with even more negative data points:

Well, just to keep in mind, Bob, keep in mind before you go there, these are foreclosures in process so they're not yet hitting the real estate for sale side market, so they are ominous statistics and I think that we have seen false recoveries before, like in the fall of '06 where there was a perception things were getting better and what looks like good activity right now and apparently getting better, I'm just wondering what kind of risk are you incorporating into your expectations and concerns as it relates to this subject. But also you're benefiting to some extent, I wonder what percent the market is really incentivized to use the tax credit, because the tax credit right now is pulling forward demand….

To this, Toll management forthrightly pointed out that Toll Brothers houses are too expensive to benefit much from an $8,000 tax credit, leaving our G.A. nothing else to do but wag her finger at both the company and trigger-happy homebuilding investors, by simultaneously advising Toll management how to look at their own business, while also slamming trigger-happy homebuilding investors:

...I certainly appreciate Toll is relative to the market. I guess what I'm just trying to point out and make sure that Toll Brothers is thinking about as well is the headwind that might be fourth quarter 2009, macro fourth quarter headwind or first quarter 2010, not to mention all the unemployment. It just sounded like you guys are very optimistic and I just don't understand why this is not being taken into more consideration and maybe you are thinking about it. So maybe that's one of the reasons you're not projecting 2010 earnings and revenues or revenues and earnings, but it seems like the market is very excited and wondering what your perspective is, generally, if you think the worst is behind us, how do you thing about this in that outlook? So I think I got where you guys are, so I appreciate it.

Bob Toll, to his credit, declined to take the bait:

Well, the other side of the answer that I gave you is that, notwithstanding our optimism, we haven't changed any of the thresholds with respect to the land that we're willing to buy and we haven't bought much at all, yet, and that's -- and we've been beaten out and that's probably because we are maintaining threshold. So while we're optimistic, we are also -- we're also unwilling to make bets on the future being much different than the current market, which is how we analyzed the land that we purchased.

Now, you might think that a Grumpy Analyst—unable to get under the skin of management and force them to break down like those sociopaths on The Closer, who we suspect are driven to confess their triple murder/rape/carjacking/identity theft crime sprees every week not so much by the force of Kyra Sedgwick’s crack logic, but by prolonged exposure to her weird circus clown lipstick and high school glee-club Southern accent—might resort to bitter irony or sarcasm to win the final point.

But this is not how these calls go. After all, Wall Street’s Finest need to maintain the good graces of the companies they are paid to follow.

Thus it is that our Grumpy Analyst concludes the dialogue by using exactly the words her predecessors with Grumpy Analyst Syndrome have done from time immemorial: a variation on the dreaded “Great Quarter, Guys” cliche:

Well, that's very helpful. Thanks, Bob. Appreciate it. Good quarter, guys.

Whether there will be more such “good quarters” to come for Toll Brothers or any other home builder, we make no predictions. Nor would we expect the stocks to duplicate their March-to-August performances any time soon.

But we’d certainly bet that so long as there are homebuilding followers afflicted with Grumpy Analyst Syndrome this severe, the stocks have seen their lows for this cycle.

Optimistic? How dare he!


Jeff Matthews
I Am Not Making This Up


© 2009 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

11 comments:

outlaw josey wales said...

Jeff,

I really hope you're correct. However, personally I don't see the fundamentals improving any time soon. For example, CRE, housing, unemployment, salaries. If people are losing jobs, if salaries do not increase, and if they're tapped out on credit, where is the economic boost going to come from given that we're ~70% dependent on consumer spending?

I guess I'm not convinced that things are improving solely on the basis of the Dow and/or S&P.

Ben said...

Hey Jeff,

Great post, I found it really funny because of how true it was - I have noticed it in a lot of the stocks I follow. Quite frankly, I sometimes share the sentiment of the give-up analysts but I've realized since I was too negative, even in stocks I personally own.

Thanks for the amusing anecdote.

Aaron said...

Jeff: Me thinks the "grumpy" analyst in question suffered from hindsight bias when evaluating Toll's future earnings power.

What I always find amazing with buy/sell side analysts is how long they take to downgrade a stock to "neutral" (never a "sell" - can't offend those companies they "keep"), which is well after the share price has dramatically declined.

For those readers with an intellectual bent, I thought I'd include a recent study done on the relevance and bias on analyst recommendations of bankrupt companies. The study was written back in 2003 by Allen Michel and Israel Shaked. I included the link to the study here. The best parts are Part III, Results, and Part IV, Conclusion.

Great work, Professor (again)!

Anonymous said...

Amen,Mr. Mathews.

Berkin said...

Another great analyst call today; Citi analyst upgraded Marvel to hold from sell and increased it target price to $50 from $31. He also critized Disney management for paying a full price. I do not know enough about Marvel to comment on the price, which a lot of people view as a generous one, but when a company pays 61% premium to an analyst's target price in a buyout and then the analyst increases his rating for a 5% merger arbitrage premium, credibility becomes an issue.

S Sams said...

Jeff,

There have always been at least two types of analysts on Wall Street: the stockpickers and the marketers -- the latter produce 'doorstop' research reports and usually are at the top of the II list. The good stockpickers usually migrate to hedgefunds where their talent is valued.

Unfortunately, over time the street has become populated with more of the former than the latter. I appreciate that your critiques of analysts usually focus on the doubletalk and nonsequitors that some use to cover their tracks. However, identifying good stockpickers is an even greater find.

Jeff Matthews said...

S Sams is absolutely right, on all counts.

There may be a handful of analysts who've managed to do both the marketing and the stock-picking, but it's not easy.

As my first boss on Wall Street pointed out, if you downgrade a stock you immediately hack off all your clients that own it.

Hence the infamous "Downgradin Stock But Raising Price Target" routine, among others...

JM

Anonymous said...

SEPR was also a funny one this week - lots of analysts with sell or weak hold on it. Funny to watch the upgrades and rationalizations after the acquisition.

bleichroder said...

interesting choice to only publish comments that agree with your viewpoint.

Jeff Matthews said...

"Bleichroder": Beg your pardon?

Do you know of a comment that wasn't published?

Actual readers know that we don't censor for content or point of view--only Yahoo Message Board-style language.

JM

Contrahour said...

This is a fabulous post and goes straight to the point of why it's so hard to be a great long-term investor or analyst. Every investor/analyst makes the same mistake by falling in love with their position rather than taking into account new, contradictory information. To become great, you have to be able to understand your own emotional reaction to news, as well as understanding the news itself. Unfortunately, the ability to make honest self assesments seems to be in short supply these days.