George Pitcher: Investment analysts rely on sentiment not facts

Sainsbury’s chief executive wonders why good sales figures are not enough for analysts. That’s because they weren’t born yesterday, says George Pitcher

It’s a never-ending source of amazement to anybody who has spent more than 20 minutes in the investment markets of the City of London that anyone should think that the methods used in the valuation of companies amount to an exact science.

It’s been blindingly obvious for generations that the principal driver of such markets is sentiment. It is what drove US Federal Reserve chairman Alan Greenspan in the Nineties to refer to the “irrational exuberance” that was driving the bull market. With rather more exasperation, it is also what drove former Tory Chancellor Nigel Lawson to rail at the “teenage scribblers” of the City during the Eighties.

These observations, from the people who have allegedly tried to manage our Western economies, demonstrate that it is not so much money supply or inflation, or prospective earnings multiples that define corporate prosperity, but the good, old-fashioned hunch.

It was always the case, when I was knocking around the City dealing rooms in the Eighties, that those analysts who droned on about “fundamentals” in corporate evaluations missed the point as spectacularly, if less violently, as religious fundamentalists.

Fundamentalists – in any walk of life – are people without imagination. They are literalists, who understand little or nothing about mystery and faith, both of which play a central role in the City, as well as synod.

It was always those in touch with sentiment, who had a sense for and who could back a hunch, which made more money than the fundamentalists. Even those who track the indices for investment purposes – and claim to beat the majority of investors over time – will never be as prosperous as the successful spotter of under-rated value.

Analysts at US investment banks on Wall Street seem to have gone further than both fertile science and febrile imagination should allow. The authorities there are investigating evidence that analysts at banks such as Merrill Lynch – its logo is rather appropriately a bull – have been recommending shares in Internet stocks, while internally dismissing them with acronyms such as “POS” (which stands for piece of something unpleasant on my shoe).

Well, someone fetch me a feather. And there we were thinking that investment-banking analysts were paragons of independent, objective and academic thought on the trading prospects of the companies that they investigated.

Of course they’re not. As soon as you put investment bankers – who have a highly vested interest in receiving instruction in the capital markets from companies – under the same roof and brand as the analysts who evaluate them, you have a conflict of interest.

Chinese Walls are something you grow a grapevine over. Cases of conflict of interest were investigated in London regularly in the Eighties and, very largely, the investigators privately concluded that there was little to be done about the matter.

More recently, I have been told of outrageously blatant attempts by global investment banks to ramp shares in telecommunications companies to unsuspecting punters, while knowing that the costs associated with the third-generation technologies – and the licences associated with them – made their hype meaningless.

Now, just because such practices are widespread, that’s no reason to condone them. Regulatory authorities are not going to eradicate such corruption, but they should work tirelessly to maintain standards and protect investors’ interests so far as they can.

We don’t tell the police to give up just because there will always be criminals. We aspire to honest markets, just as we aspire to a moral society, and the value is in the striving, rather than the achievement, of them. Nevertheless, we should not be naive either. I don’t leave the car unlocked, with a laptop on the seat, just because it’s generally considered a wicked thing to steal other people’s property. And nor do I expect to get independent and objective investment advice from the City.

On the other hand, I don’t expect to get ripped off by cynical spivs putting my cash into Internet stocks that they know to be doomed either. All I’m saying is that we need to be worldly in our approach to City “experts”, rather than assume that they have our best interests at heart.

It is as foolish to be wide-eyed as it is wicked to be corrupt. There are far more fraudsters than any other kind of criminal in the penitentiaries of Salt Lake City, Utah, because the Mormons of that state are brought up to trust the word of strangers. Nice, but naive.

Similarly, while it is harder to make a moral distinction where no criminal activity is involved, we should be just as worldly about commercial judgements of the uncorrupt kind. Last week, Sainsbury’s chief executive Sir Peter Davis was in high dudgeon because City analysts were unimpressed by the sustainability of the recovery plan he is leading at the store group.

He thinks the fourth-quarter sales figures speak for themselves. “I don’t know what they want,” he said. “We are bloody pleased with the figures.”

Teenage scribblers, eh? I’ll tell you what they want, Sir Peter. They want fewer bloody-minded and silly little scraps with Tesco over who’s winning whose customers and arguments about prices and a little more indication that there is a long-term strategy for building your company. They’d also like to know that you can argue a case, rather than simply bluster. But that’s just a hunch.

George Pitcher is a partner at communications management consultancy Luther Pendragon


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