The power of analysis

MARY JANIGAN March 24 1986

The power of analysis

MARY JANIGAN March 24 1986

The power of analysis



Last month CBC television reported that the federal government and four provinces had turned down a request from the Bank of British Columbia for an $800-million investment package. Then, Roy Palmer, a respected bank analyst with the Toronto brokerage firm of Alfred Bunting &

Co. Ltd., made disparaging comments about the bank’s method of computing its $7.5-million net income last year.

The effect was devastating.

Within 12 minutes of opening trading the next morning, the bank’s shares toppled 85 cents to $4 on the Toronto Stock Exchange (TSE). As a result, the bank swiftly filed, and vigorously pursued, a libel suit against the CBC—and against Palmer— claiming that the report was completely erroneous.

That unusual action shocked Canada’s 1,500 financial analysts who make a living for themselves and others with their diagnosis of stock market trends. “It is normal for analysts to question whether reported profits reflect real earning power,” said Rossa O’Reilly, the president of the Toronto Society of Financial Analysts. “If analysts are being sued on that basis, it is disconcerting.”

The episode focused attention on financial analysts themselves—and the power that they wield. Every week analysts at brokerage houses or investment dealers issue reports that set out the risks and the rewards of investment in specific stocks and bonds. Those reports go to individual investors and to institutions such as life insurance companies, pension funds and trust companies who are clients of the brokerage firm. The reports can make—and sometimes break—a company. Last week William Randol, a respected oil analyst with First Boston Corp. in New York, issued a “buy” recommendation on major international oil stocks because he reasoned that oil prices had “bottomed out.” Within hours trading in oil and gas shares on the TSE increased more than three per cent.

Most Canadian analysts are more cautious. A glowing “buy” report could

cost investors millions if it is wrong— and could damage the credibility of the brokerage house. A damning “sell” report could hurt a struggling company. “If an analyst has a good reputation, he

can drive stock prices right down—it can be devastating,” said Dennis Beggs, the executive director of the Canadian Council of Financial Analysts. “But all that analyst has to do is to be wrong a couple of times—and then nobody listens again. So analysts tend to hedge their bets.”

Even if a Canadian analyst does issue a clear sell recommendation, it rarely has the same dramatic influence as a pronouncement by such highprofile U.S. analysts as Henry Kaufman, chief economist at Salomon Brothers in New York. In 1982 Kaufman’s announcement that interest rates would decline caused a record jump in the Dow Jones industrial average. The New York market is dominated by a handful of large brokerage firms which draw most of their business from institutional clients with huge pools of capital. As a result, it is easier for a prominent analyst to have a more dramatic and immediate effect.

In contrast, Canada has few star

analysts whose pronouncements create enormous market swings. Philip Heitner, a portfolio strategist in the Toronto office of Montreal-based Nesbitt Thomson Bongard Inc., also points

out that Canadian markets are heavily influenced by the U.S. market. As a result, Canadian analysts are unlikely to make sweeping recommendations without consulting U.S. market trends.

But Canadian experts can affect the future of individual companies. Geoffrey Carter, a mining analyst at Midland Doherty Ltd., wrote a brutally frank report on Denison Mines Ltd. in January, 1984. That report predicted significant losses at Denison’s Quintette coal mine in British Columbia—and revealed that some Japanese buyers were reneging on their purchase orders. Since then, the stock has fallen about 30 per cent—while the TSE mining index declined only slightly.

Analysts’ reports can also drive up stock prices. In late 1984 Burns Fry Ltd. studied Inter-City Gas Corp. of Winnipeg and its acquisition of Northern and Central Gas Corp. Ltd. of northern Ontario and Manitoba. Then, the firm issued a “buy” recommendation—and the stock climbed to $16.75

last year from $9.50. Said Douglas Cunningham, a regulated industries analyst at Burns Fry in Toronto: “If a company’s stock rises or falls, it is the result of the company’s own hand. We interpret facts to report a story—but we do not create it.”

Canadian analysts tend to be modest about the power they exercise, but the companies that they scrutinize—and their clients—freely acknowledge it. Every 18 months Brendan Wood of Tutsch and Partners Inc. of Toronto consults most of Canada’s large institutional investors to rank analysts based on the amount of commissions they generate

for their firm (page 38). John Chase, corporate affairs vice-president at the Vancouver-based conglomerate Genstar Corp., said that there are about two dozen analysts with in-depth knowledge of his firm. “If one of those key people came out with a statement that dinged us, it would be significant—especially since other analysts follow them,” he said.

For analysts, a career based on predictions about the future is a difficult but often financially rewarding one. Most of them have university degrees in business or economics. Analysts who scrutinize highly specialized fields such as mining often have engineering or geology degrees as well. In return, analysts earn between $50,000 and $250,000 a year in com-

bined salary and bonuses based on the business they attract to their firm’s salesmen.

Conscientious analysts base their predictions on a wide range of corporate data. They study current—and anticipated—earning power, liquidity, management capability, a firm’s record, the historical value of the shares and the amount of control that a firm has over its product prices.

Top analysts also conduct personal interviews with senior corporate executives to discuss the firms that they monitor. “It is the one area where there is an opportunity to go beyond the material

that anyone gets in the mail,” said O’Reilly. The resulting reports are usually crafted for institutional investors, largely because of their huge spending power. All clients—from the largest fund to an individual with $1,000 to

invest—have access to the analysts. But there is more than $70 billion held in the 75 largest investment funds, and that can buy a great deal of personal attention.

Alix Granger, a portfolio manager and a former analyst at Vancouver’s Pemberton Houston Willoughby Inc., said that analysts sometimes issue a report for institutional investors—and then publish a shorter report for retail brokers. “At some firms, brokers do not have easy access to the analysts. It clutters up their time and sometimes [brokers] are not allowed to talk to them,” he said. “Some analysts have an utter disdain for the retail side.”

The requirements of those large institutional investors are also partially responsible for the fact that there are few sell recommendations. Analysts know that it is difficult for those investors to sell or buy large blocks of shares without affecting stock prices. Instead, analysts concentrate on the long-term outlook, sometimes to the frustration of smaller investors who might want to make short-term deals.

Analysts also face potential conflicts of interest. Owners of many brokerage houses often find themselves in an uncomfortable position: their underwriters may be selling a new share issue for a company at the same time that their analysts are circulating unfavorable reports about it. Michael Dunn, research director at the brokerage firm of Capital Group Securities in Toronto, says that pipeline utility companies are one group that has influence with the senior management of brokerage houses because they use those firms to raise large amounts of corporate financing. “They say, ‘You control that guy or I am going to take those commissions to someone else,’ ” said Dunn. Analysts also risk losing their valuable corporate connections if they are too negative. Said Granger: “I have seen many instances where analysts have put out a sell order and a company will no longer talk to them.”

Despite those pressures, most analysts tell the truth because their reputation depends on the accuracy of their reports. Jaak Puusepp, a longtime forest products analyst at Pemberton Houston, is grateful that he has been out of town occasionally when he does not favor a firm that Pemberton is underwriting. “Last January, when our company was involved in a particular forest products issue, I went on a trip to Toronto for a week,” he said. O’Reilly adds that slanted research is of no use to anyone. “It has to be impartial,” he declared. “A conscientious analyst always remembers that he is dealing with other people’s money.”