If you want to know why so many people come to stock picking with a trader’s, rather than an investor’s, mentality, one reason is that Wall Street analysts so often seem governed by the very same mentality. Take this week’s raft of upgrades and bullish comments on some Internet bellwethers by analysts at firms ranging from Merrill Lynch to Paine Webber. The bullishness was framed in terms of the long-range potential of these companies. But the fact that the comments came out this week, after these stocks had already rallied strongly from their recent lows, was telling. Instead of making a real contrarian call, telling their clients that these stocks were excellent buys no matter what the market was saying in the short-term, the analysts were just bandwagoning.
Merrill’s Henry Blodget, for instance, issued a report Wednesday in which he raised his rating on Amazon.com and Yahoo to “near-term buy” from “accumulate,” and added that he also expected six other Net companies–AOL, Barnesandnoble.com, Excite@Home, eToys, Inktomi, and Lycos–to do well in upcoming quarters. Now, set aside the complete foolishness of distinguishing between “near-term buy” and “accumulate” (how, again, am I supposed to accumulate shares if I don’t buy them? and does near-term buy mean that these stocks are a long-term sell? or perhaps just a long-term accumulate?). What was really interesting was the reasoning behind Blodget’s call.
“We believe [the stocks] offer a sound way to play the fundamental strength and renewed investor enthusiasm we expect to see during the fall and holiday shopping season,” he wrote, arguing in essence that places like Amazon and eToys could expect to see booming business at Christmas, while portals like Yahoo would reap the benefits of all the new online shoppers, most of whom would pass through a portal to get to the e-commerce sites.
This is plausible enough. But if it was true Wednesday, then it was certainly true a week and a half earlier. So why didn’t Blodget issue the report, say, on August 10, when Internet stocks were cratering and people were talking about a permanent end to Net mania?
After all, nothing has changed in between to make the impact of the upcoming fall and holiday shopping seasons any greater. The long-term values of Amazon and Yahoo, whatever they are, have not changed, either. The only difference is that Amazon traded at $82 a share at midday on August 10 and closed at $109 a share on August 17, the day before Blodget issued his report, while Yahoo rose from $116 to $138 in that time and AOL jumped from $80 to $97. Perversely, the fact that these stocks are now more expensive than they were a week ago makes them seem less risky to analysts.
Does this make sense? Of course not, at least not if you believe that eventually the price of a company’s stock reflects the discounted value of all the future free cash flow of that company. (Which it does.) After all, normally you want to buy stocks when they cost less, not more. But in the world of momentum investing, which is to say the world that all those traders who “watch the tape” live in, buying stocks after they’ve risen is what makes sense. And this same (il)logic informs way too much of the work of Wall Street analysts, even those who have an excellent sense of the economics of the companies they study. The odd thing, of course, is that you’d think that Blodget’s clients would have to be furious that he was telling them to buy Amazon when it was far more expensive than it had been a week and a half before. But since his report helped bump Net stocks up yesterday, they probably didn’t even notice.