Investment company research reports puffery

By DAVID MOON, Moon Capital Management, LLC
April 28, 2013

On April 16, investment bank Jefferies lowered its price target on Apple stock to $420 per share. The shares were trading at $419 at the time.

Seven months earlier, when the stock was trading at $673, Jefferies forecast the shares at $900. Nothing had changed about Apple in those seven months, except that the company accumulated another $14 billion in cash.

After the stock fell 40 percent, Jefferies decided it was worth less.

So much for accurately predicting the score of last week’s game.

The too little known secret is that most investment company research reports are motivated more by an incentive to create transactions than by an understanding of the value of a company. These published reports are excellent at reciting every bit of minutia in an annual report, but often offer little assistance in knowing a company’s worth.

Standard and Poor’s admitted as much this past week in response to a US Justice Department civil suit alleging that the company committed fraud when it represented its ratings as independent and objective.

Standard & Poor’s has, for decades, maintained that its ratings are not influenced by the fees it receives from the companies it reviews.

In response to allegations that investors lost money by relying on S&P’s self-proclaimed of independent and objective research, however, Standard and Poor’s own lawyers referred to two earlier court decisions that the company’s claims of independence “were mere commercial puffery.”

Of course they are. Institutional investors have known this for years.

Few individual investors realize that, like Jefferies’ Apple forecasts, Standard and Poor’s credit ratings are simply confirmations of already known information.

When S&P downgraded the debt of the US government in August 2011, the market yawned, because every quasi-sophisticated investor already knew the US wasn’t a AAA credit.

The research report was worthless.

Does a small investor have a chance?

The best answer for most small investors is to simply use mutual funds. Choosing a suitable fund or two from the 29,000 available fund classes may seem daunting, but with a little bit of research at most people can make a good decision without paying someone to pick eight funds for them.

If you want to pick your own stocks, do your own research.

Jim, my friend in Gatlinburg, has outperformed the S&P 500 with his stock picks over the past 20 years. He buys things that he understands, have low P/E ratios and little debt. And then he holds. He just gets up, goes to work and ignores market declines.

Some of the analysis you read or hear on CNBC is valuable, but not much of it. If you hear an expert tout a stock, and then note that he doesn’t own any of it, turn off the TV. Throw away the report.

When an analyst at XYZ brokerage firm says he doesn’t own Groupon, but it is a “moderate buy” or “aggressive hold,” I chuckle and hope our clients aren’t watching.

When Mario Gabelli or Warren Buffett talks about a company in which he just invested $150 million, I listen.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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