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For investors who jumped into stocks during the market boom of the late '90s, making money seemed like a sure thing. With all the "strong buy" and "buy" ratings tossed around back then, analysts faced little risk of being held accountable. How things have changed. Today, with so many stocks in the doldrums, brokers are taking heat from angry investors who can't understand why the "buys" didn't turn into "sells" as the market started to tank.
Truth is, stock analysts rarely issue "sell" ratings. Typically, the lowest recommendation they put on a stock is a "hold." It has long been one of Wall Street's dirty little secrets that a hold-rated stock often isn't worth holding onto at all. But the downturn in the economy and the market have now given such a rating a more nuanced meaning.
With industries slumping, high-tech and otherwise, when a stock is labeled as a "hold," it shouldn't necessarily be interpreted as a red flag or a sign to sell. Many companies are truly in a holding pattern, and business will begin picking up as the economy starts to rebound. With those companies, a "hold" rating can be a signal to investors to do just that -- hold on.
MORE "HOLD"ING. This is a touchy subject among Wall Street analysts, who lately have come under fire for how they determine their stock recommendations. They say their "hold" ratings mean the same now as they ever did. Perhaps, but one thing's for sure: The number of stocks rated "hold" is on the rise.
Overall "hold" ratings, which are used interchangeably with "neutral" among most analysts, have risen to about 34% of the total so far this year, according to First Call/Thomson Financial, which tracks earnings estimates and stock recommendations. That's up from 28.5% at the end of 2000. Smart investors know they can no longer look at a "hold" rating and assume it means the stock is a dog. "Analysts hate [hold-rated stocks], but can't bring themselves to say 'sell,'" says Michelle Clayman, chief investment officer at New Amsterdam Partners. "Sometimes the ones that are 'hold' might actually be diamonds in the rough."
Some analysts are quite clear that a "hold" now means something different from what it did when irrational exuberance prevailed. "My 'neutral' rating now would be different than my 'neutral' rating a year ago. The rating now takes into account the current environment for the company, for the stock -- relative to competition and the stock market," says Pacific Growth Equities analyst Brian Alger of his rating of Cirrus Logic (CRUS
), a communications chipmaker.
Alger cites the difficult macroeconomic conditions affecting the company, adding that "the outlook for Cirrus Logic is particularly negative." One way, though, to interpret that "hold" and others is to bear in mind that many downtrodden businesses -- and their stocks -- will someday bounce back.
WHAT'S THE TONE? Examples? Philip Orlando, chief investment officer at Value Line Asset Management, points to a recent research report downgrading to "hold" several tech companies like JDS Uniphase (JDSU
) and Corning (GLW
). These stocks had slipped 90% by the time of the downgrade, which did not appear to be sparked by industry developments. "I don't know that I would blindly jump in, but it does cause me to say maybe I should look at these stocks," Orlando says.
And don't forget former highflying stocks that have been reduced to "neutral" or lower. Computer networking giant Cisco Systems (CSCO
) has been downgraded from "strong buy" to "hold" by more than a few analysts. Yet its problems are largely cyclical. Over the long term, Cisco is tops in its industry and the stock will make a comeback, says Jeffery Kleintop, chief investment officer at PNC Advisors. He sees the negative sentiment as a chance to buy the stock cheaply.
Retail investors can learn a lot about a company by assessing the tone and language of analysts' research reports. At times, it's clear that while a company's prospects are fundamentally solid, increases in price are not around the corner. "We sometimes found our best ideas among stocks that are rated 'hold.' They're relatively overlooked," says Clayman. "We do the research and find it's intriguing."
For example, in August, 2000, most analysts were expecting the housing market to slow dramatically in 2001. The ratings on home-building stocks were mostly "holds." Shares of the largest homebuilder in the U.S., Pulte Homes (PHM
), were trading cheaply, in the mid-$20s range. "Most analysts were very cautious that the strong sales of the recent past would last in a slow economy," says Eric Jemetz, equity analyst with New Amsterdam Partners, who adds: "Our analysis showed there was more to it than that." Indeed, home building has held up in the economic slowdown and Pulte's shares now trade at around $41.
WATCH FOR CONFLICTS. A savvy investor also needs to assess how much conflict of interest might be built into an analyst's opinion of a company. According to a Securities & Exchange Commission study, analysts at all major firms helped the firms' investment bankers market new share issues, as Laura Unger, the acting SEC chief, told Congress recently.
Among other things, the analysts participated in road shows for companies about to go public, as well as initiating coverage of prospective banking clients. The SEC also found that 25% of the analysts reviewed in its report made investments in private startups before the companies went public -- and later started coverage on the newly public companies with "buy" ratings.
So how do you know when "hold" means "sell?" One quick way is to find out if the firm that issued the rating has done significant underwriting for the company, says Kleintop. "If they had in the last couple of years I'd have less confidence that the rating really means 'hold,'" he says. Scott Cleland, CEO of Precursor Group, also recommends that retail investors give more weight to the recommendations of brokerages that don't do investment banking. Few research houses are truly free of potential conflicts, but Cleland points to Argus Research, Value Line, and Bernstein Research as firms with no exposure to conflicting businesses.
In the end, investors should never rely simply on an analyst's rating to make a stock-buying decision. Too many learned that lesson the hard way by rushing into stocks rated "strong buy," only to see them tumble when the dot-com bubble burst. But in this period of volatile markets and a slumping economy, it might be worth taking a second look at some of those stocks downgraded to "hold." By Amy Tsao in New York