Tuesday, August 26, 2008

Marvell Downgrade, Round Two (or, Analyst Bull)

This column is not called Dissecting the Bull for no reason.

In this entry I am going to dissect games sell-side analysts play, using today's downgrade of Marvell Technology (MRVL) by Jefferies as an example. The stock price plunged 7% so far today. Marvell is about to hold its analyst conference for the quarter ending August 2, 2008 this Thursday, August 28th.

This looks suspiciously like events the week before the last Marvell analyst conference. See my Marvell Reality Tops Goldman Downgrade to make a comparision, and my summary of the fiscal Q2 2009 Marvell Technology analyst conference for real information.

This does not mean that I know that Jefferies is wrong in this particular case. Rather I want to put this and all analyst upgrades and downgrades into a broad perspective.

First, for those who don't know me, a reminder of my credentials and possible biases. I work freelance as a buy-side analyst for an investment management company. I also do a variety of things for technology companies, let's just call it consulting. I also am developing a web-based business that will be beta-testing soon. This year my only paying tech client has been Microsoft, but that is just a coincidence. I was asked to do a job for Cisco, but refused it due to a scheduling conflict. I also have investments in the stock market, including Marvell. That's why I noticed the price drop today.

Buy-side analysts are under pressure to give an accurate picture of reality for their clients, who are investors. Publicized upgrades and downgrades come from sell-side analysts. Their job should be to give their ultimate clients, individual and institutional investors who follow their advice, an accurate picture of reality. Sell-side analysts are paid by their employers, who are investment banks and brokerage houses. Their employers make money two ways: from their own speculation, and from fees, including trading fees. Generating fees requires getting clients to trade. Upgrades and downgrades induce clients to trade and generate fees. In addition, the tempatation to use the upgrade/downgrade for an internal trading edge, or to give priviledged clients an edge, is always present.

That said, the vast majority of buy-side analysts do their jobs in as honest of a fashion as they are able. Some are better at analysis than others, but that is just human nature. I've been very impressed by some of the sell-side analysts I know through participating in analyst conferences.

Now take a look at varying types of downgrades (flip them for upgrade equivalents). The most common kind is news-based. Usually a company says it had lower than expected revenues, or had some kind of foul-up, and says it to the public. Analysts issue downgrades. You don't need the analysts for that, so you can trust them.

Sometimes, using actual research, a particular analyst will come up with something no other analyst has, at least at first. The woman who picked Enron apart is a good example. Unfortunately, chance playing the role it does, sometimes even this does not help investors much. These downgrades are often difficult to verify independently, until it is too late. Sometimes a plus on the other side of the balance books, perhaps a client making an unusually large order, makes the analysis less important than it would be if all other things were equal.

Finally, we have the Hail Mary downgrade, which could be a cover for just getting clients to sell some stocks to generate commissions. In a time of economic turmoil, these are a good bet for analysts, because something could have already gone wrong, or could go wrong in the near future, so if you are right you look like a genius. There is always some sort of cover story, that makes it look like it is based on actual research. Often these downgrades just look past the truly predictable event horizon and lower earnings estimates for a year from now by a few pennies.

The problem for investors, of course, is that it is difficult to sort out the types of downgrades. Failure to believe a downgrade, when it has a real basis, can be quite dangerous.

At the Marvell analyst conference this Thursday (I'll have a summary [Marvell August 28, 2008 analyst conference] posted soon after it is over) questions will be asked, and Marvell management will give its answers. Could Marvell be hurt by the economic downshift? Sure, it has many large clients. A downturn in a client's business would effect Marvell. But I would not bet against Marvell at this point. I would not want to be any company competing against Marvell head-to-head. Marvell is ultracompetive and has crushed its competition repeatedly. It is in the process of entering several new fields, and seems to be preparing to repeat its history of success. Most notably in the past 2 years it acquired a money-losing division of Intel and turned it into a money maker.

Short term players have no choice but to panic when an upgrade or downgrade goes against their short term bets. Long term players can stick with their basic analysis and change it when real news warrants that.

Keep diversified!

More data:

My Marvell page

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