How to spot a bad financial analyst

It's earnings season, so before buying into an analyst recommendation make sure to sanity check it. Here are ways to spot outrageous claims.

It's earnings season, so before buying into an analyst recommendation make sure to sanity check it. Here are ways to spot outrageous claims.

1. Style over Substance

Beware of the table-pounder who promotes stocks without hard evidence. These bulls are charismatic and personable, but rely on emotion sprinkled with faulty logic. They sometimes mask ulterior motives. Even after the embarrassing revelations of financial bubbles, analysts still push stocks of banking clients and are richly rewarded. 

What stops the bulls? The cliff. In the endgame, a data point can nullify conventional wisdom sending the stock into a freefall.

But not all analysts are shady salesmen.  A small percentage has industry expertise and does homework. They do surveys for feedback, and they find contrary indicators. A tiny subset has forensic accounting skills and digs into financials cross-checking with third-party resources from the government, industry or other companies. These analysts look for inconsistencies and gather enough facts to make bold bearish calls. 

2. Vague Descriptions

A company description should be quantified and concise.  An example is: "Cisco is a $45 B company that makes routers, switches and servers for enterprise networks".  A bad one is, "Cisco is a global leader in communications innovation".  You invest in products and services not vagaries. A key way to identify B.S. is to look for long streams of adjectives, like "state of the arts, low bit error rate equipment with many bells and whistles". My experience is the uninformed combine long descriptions with clichés.

3.  Excessive Adjectives

Confusing adjectives have no place in financial analysis. Calling a quarter "strong, weak, good or bad" connotes nothing. "Qualcomm missed the quarter based on component shortages but the outlook is good" is contradictory. It does not give the essential elements that investors need, namely catalysts (contracts or deals), costs (supply chain) and milestones (sales forecasts). The analyst should quantify performance and cite time periods. Without these details, the analysis should be ignored. 

4.  Hype and Hyperbole

Financial analysis is not advertising, so claims of "truly amazing performance" or "enormous gains" and other exaggerations don't fit. Hyperbole and superlatives create buying frenzies, which are black holes for investors.

5. Techno-Speak

Poor analysts lapse into industry jargon and stats, like "The New iPad has a 2048 X 1536 retina display, an A6 processor and supports 4G LTE". Analysts should explain cost-benefits for new features. An assessment of customer price sensitivity would be good. [More from Forbes: 10 ways to be more confident at work]

6. Questionable Valuations

Stock valuations are standard formula to predict stock prices and are based on projected revenue or profits. Results may differ from reality as there are many unaccounted variables in future streams discounted to the present. Watch out for use non-standard metrics, like taking the company's cash out of the analysis. They make the valuation look lower (better).

7. Investor Saturation

For the stock to go up, investor demand must exceed supply. If your nanny just bought a share of Apple, chances are the market is saturated and it won't climb even if revenues grow 70%. At some point, good news is discounted into the stock, or expectations may have run away.

8. Fantasy Price Targets

Price targets are an arms race that serves the analyst, not the investor. There is little downside for an analyst to bid up a price.  When Amazon was trading at $200, Henry Blodget, who was later barred from the securities industry, set his one-year price target at $400.  His rationale: if right, I will become a rock star and if wrong, no one will remember.  The stock hit the target in a month, and emboldened Henry produced excessive hype mislabeled as financial analysis. He was wrong and everyone remembered. A reasonable analyst sets price targets with 20% headroom and recalibrates on news.  The $1000 price targets on Apple, now trading at $560 may be fantasy.

9. Repetition

Ignore the pump-and-dumpers that scream at every 2% contraction, it is "Christmas in June".

10. Starmine Sweepstakes

A recent study suggests Starmine, which ranks analysts according to accuracy of forecasts, may be gamed. A serial winner in Starmine rankings with top marks across-the-board for most of their companies may be a cheat.

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