MARKET COMMENT
Broker Ratings Should Be Banned

By Stuart Watson (TMFTiger)
August 16, 2001

Great Titchfield Street, London -- Every now and again I watch the financial telly programmes. The one thing that really ticks me off about them is their insistence on summarising how brokers rate a particular share whenever they talk about them. You know the sort of thing, 6 brokers rate it a buy, 2 a hold etc. Usually it's the first bit of information talked about. Very rarely do we hear about a price to earnings ratio, a dividend yield or, heaven forbid, cash flows.

Why anyone bothers to pay the slightest bit of attention to broker ratings is beyond me. They are possibly the most useless bit of financial information in existence. In fact they should banned outright.

First of all, they are often out of date. If you inspect the individual ratings you can find some are several months old and have been rendered obsolete by recent announcements or price movements. However, whenever a broker blows the cobwebs off his research and changes a company's rating the decision is covered in great detail, in particular by our friends on TV.

Secondly, there are massive conflicts of interest involved. Huge. Enormous. The companies publishing the ratings rely on fees from corporate transactions like acquisitions and demergers for a significant part of their income. Therefore most of the ratings published tend to be buys as the companies don't want to exclude themselves from any juicy fees in future. In addition, brokers who have the courage to come out with negative comments often find themselves cold-shouldered by the companies concerned and last in the information queue. In fact, at the height of the tech boom last year some research showed that a ridiculous 99% of ratings were buys. This has led to a swathe of class action lawsuits in the US.

In order that ratings don't offend, a bizarre code is used. To translate broker ratings you need to knock everything down a notch. So a "Strong Buy" means buy whilst a "Buy" rating actually means "hold", i.e. don't buy them but keep them if you've got them already. A "Hold" rating is essentially sell, i.e. run for the hills. A "Sell" rating is even worse. That means run for the hills and once you get there, keep running.

Whilst everyone in the City knows this code exists many private investors do not, especially those new to the stock market. It seems utterly pointless anyway. If those involved know Hold means Sell why bother with the charade. It's another unfortunate example of how, in the City, perception is given more weight than the facts.