How analysts failed investors by not seeing L&T's turnaround

The market's euphoric reaction to L&T's quarterly results clearly shows how investors were caught on the wrong foot. After a strong gap up opening on Thursday, the stock steadily moved higher to close at the high point of the day, surging 14.04 per cent on the exchanges.

The stock alone contributed 164.82 points to the 485 points move on the BSE Sensex. The stock has stayed flat when it opened for trade on Friday. 

For retail investors, who rely largely on analyst recommendations, the change in outlook has come as a nasty surprise. It does not require rocket science to figure out that after such a phenomenal performance by the company, the stock is a buy.

Analysts’ had similarly put a sell recommendation on the company after it had reported poor numbers in its June 2015 quarter. The stock topped a price of Rs 1,888 in July 2015 and corrected sharply post its results.

The stock was on a continuous downtrend and touched a low of Rs 1,016.5 in mid-February 2016. On Thursday it closed at Rs 1,472.60, nearly 45 per cent from the bottom, which is when we saw analysts changing their recommendations. Agreed that there is more steam in the rally given the strong fundamentals, but that is an obvious deduction from the results. Even a retail investor can figure that out and does not need informed analysis from an analyst.

A general grouse that investors holds against their brokers is the poor quality of recommendations. There is very little to choose from one broker to another in terms of service, so it is the research calls which separates the men from the boys. Industry figures point at a churn of 30-40 per cent of clients on a yearly basis among brokers. All market tops have been made when most of the analysts have a unanimous buy decision. The reverse is true for market bottoms.

To be fair, there were many broking houses with a buy recommendation on L&T much before its results. Some were giving buy calls all throughout the one-way fall of the stock in the last one year.

It is not easy to catch the top and the bottom of a stock’s movement, but for an analyst who is tracking a company like a hawk, it should not be too difficult to observe the change in their fortunes. That is what they are expected to do, rather than come to conclusions on the basis of company press releases. 

Fundamental analysts swear by Warren Buffett but forget to learn from his teachings where he advises investors to be greedy when everyone is fearful and fearful when everyone is greedy.

Analysts either change their recommendations frequently in order to generate more brokerage or due to lack of vision. Most cannot see beyond a quarter. Seth Klarman, author of a book on value investing titled ‘Margin of Safety’ puts it succinctly saying ‘Analyst recommendations may not produce good results. In part this is due to the pressure placed on them to recommend frequently rather than wisely.’

Fred Schwed’s book ‘Where are the Customers’ Yachts’ written over 75 years ago describes the relationship between broking industry and the clients and most of the points raised are still valid today. On the point of who is to blame for poor advice, Schwed writes ‘The burnt customer certainly prefers to believe that he has been robbed rather than that he has been a fool on the advice of a fool.’

At the end of the day, a retail investor needs to develop the skills of investing. It is his greed for overnight success that makes him chase recommendations from one broker to another. Legendary investor and Warren Buffett's partner Charlie Munger says 'You don’t have to be brilliant, only a little bit wiser than the other guys, on average for a long, long time'.