Risk Ratings Aimed at Wary Investors
Hey pal, want to know a cold stock to avoid?
In a sign of the tough times on Wall Street, some investment firms are putting more emphasis on identifying stocks to ignore or sell rather than pitching stocks to buy.
Typically, the firms issuing these risk ratings on shares are independent researchers that are playing up their distance from traditional brokerages, which have been denounced for being blindsided by the fall of Enron Corp. and numerous technology stocks over the last two years.
Florida-based Weiss Ratings Inc., which for years has issued financial risk ratings for banks, brokerages and insurers, started a stock-rating service in the fall, shortly before the Enron and Kmart Corp. bankruptcies.
“Many people automatically assume that big or well-known companies are financially sound,” said Martin Weiss, chairman of Weiss Ratings. “Now that some of the big names like Enron and Kmart have fallen, however, hopefully more investors will wake up to the need to consider a company’s true risk, using reliable, independent sources.”
On Thursday, discount brokerage Charles Schwab Corp. said it will launch a computer-driven stock grading system that will give each of 3,500 issues a grade between A and F. Schwab, which historically hasn’t given investment advice, said it will recommend that clients sell or avoid the lowest-rated shares.
Schwab is making a play for disillusioned customers of traditional brokerages. With the latter firms under fire for allegedly slanted research that urges investors to buy or hold most stocks and sell very few, independence from Wall Street now is considered a competitive edge--even though experts caution that no stock-rating system should be viewed as infallible.
“There is clearly a crisis of trust among investors about what’s going on on Wall Street,” Schwab co-Chief Executive David Pottruck said Thursday at a news conference in New York.
Big brokerages such as Merrill Lynch & Co. are under federal and state investigation for alleged conflicts that, critics say, have spurred the firms’ analysts to butter up even shaky companies with glowing stock ratings in an effort to keep or win lucrative investment banking deals.
By contrast, independent research firms such as Weiss say they have no business ties with the companies whose shares they rate, and thus are free to be objective. These researchers generally make money by charging investors for their reports, whereas brokerage research usually is free to clients.
Weiss issues risk, performance and overall investment ratings on 7,000 stocks. Risk ratings are based on such factors as a company’s debt load and stability of cash flow; performance ratings incorporate recent profit and share-price strength; overall investment ratings are a combination of the risk and performance ratings--an assessment of a stock’s risk-reward trade-off.
“By factoring in risk, our rating system is designed to correct the deficiencies that we feel have plagued most stock ratings issued by Wall Street brokerage firms,” Weiss said.
As of April 30, 21% of companies rated by Weiss had investment grades of A (excellent) or B (good); 30% were rated C (fair); and 49% were rated D (weak) or E (very weak).
By contrast, “sell” ratings comprise just 2.5% to 3% of all Wall Street brokerage stock ratings, according to data tracker Thomson Financial/First Call. The vast majority of shares are rated “buy” or “hold” by brokerages--which has been the case throughout the stock market’s decline of the last two years, even though brokerages say they also factor risks into their ratings.
Though Weiss’ ratings are relatively new, they correctly identified some of the worst-performing stocks of recent months.
On Dec. 10, Weiss highlighted 13 of its lowest-rated stocks and 13 of its highest-rated rated issues.
Since then, the lowest-rated shares, including US Airways Group Inc., JDS Uniphase Corp. and Xerox Corp., have lost an average of 33.1%, while the highest-rated stocks are up an average of 14.9%.
Of the 62 publicly traded companies to file for bankruptcy protection in the first quarter, Weiss said it rated 36 of them at least three months before their Chapter 11 or Chapter 7 filing, and 34 of those got “weak” or “very weak” investment ratings of D-plus to E-minus.
“The handwriting was on the wall in big bold letters, months in advance at every one of these companies, especially the giants like Kmart and Global Crossing,” Weiss said. “And yet, major Wall Street firms continued to maintain ‘buy’ or ‘hold’ ratings for most of their shares, often until the bitter end.”
Still, some financial advisors note that because Weiss’ stock ratings have a short track record, investors should be careful about judging their success.
Heavy Debt Loads Can Trigger Low Ratings
Mike Nozzarella, a financial planner at Tarbox Equity in Newport Beach, said all stock research must be taken with a grain of salt.
Many companies get low safety ratings from various independent research services because of heavy debt loads, even though the firms’ cash flows may be strong enough to service the debts, he said.
Nozzarella’s firm might use shares of wireless telecom firm Nextel Communications Inc. in “aggressive” client portfolios, he said, even though the stock gets low safety ratings from Weiss and from Value Line Investment Survey, another independent researcher.
Nonetheless, Nozzarella and other advisors say independent stock research provides needed balance for Wall Street’s unrelenting bullishness on stocks.
Value Line, best known for its “timeliness” ratings on stocks, and Standard & Poor’s, which along with credit ratings issues stock ratings for individual investors, are among the most respected independent firms with long records, financial advisors say. Both have beaten the market over the long haul with their top-rated stocks.
Investment services such as MSN Money and mutual fund tracker Morningstar Inc. have gotten into the stock-rating game more recently.
MSN Money, Microsoft Corp.’s financial site, launched free stock ratings last June under the name StockScouter. Like Value Line’s ratings, StockScouter’s ratings are based on a quantitative, or number-crunching, evaluation model that weighs specific hard data on companies and stocks, instead of relying on an analyst’s subjective opinion.
Morningstar’s ratings, by contrast, are partly determined by analysts’ subjective views. Chicago-based Morningstar began issuing stock ratings in August, said Pat Dorsey, director of stock analysis. Ratings and analyst reports are a service for the firm’s fee-paying “premium” Web site users, but highlights are posted on the site’s free area.
Some money managers who pen investment newsletters also have been getting into the game of emphasizing lists of stocks to sell rather than to buy, playing the Enron card.
Louis Navellier, a fund manager based in Incline Village, Nev., warned in a recent e-mail to prospective clients that “there are tons of companies still bleeding red ink. And scattered through that list are the next Enrons, the next Global Crossings--companies that will break your heart and bust your wallet.”
In a report, Navellier targets “99 Stocks You Must Sell Now,” including many big names
Pitching his Technology Investing newsletter, money manager Michael Murphy of Half Moon Bay, Calif., invites recipients of a recent e-mail to view a free report unmasking three tech stocks to sell immediately.
Murphy says he has followed the tech industry for 30 years. “I’ve even been known to take new devices apart just to see how they work,” he boasts in the report.
But some critics and competitors have picked apart his record as a fund manager. The Monterey Murphy New World Core Technology mutual fund is down an annualized 9% over the last five years, according to Morningstar, and the Monterey Murphy New World Technology fund has lost an annualized 19% in the period.
The bottom line, financial advisors say, is that investors should be just as careful with recommendations to sell stocks as they are with recommendations to buy.
Josh Friedman can be reached at josh.friedman@latimes.com.
