A study of the ratings systems at 30 brokerage firms showed significant improvement in their identification of companies heading into bankruptcy. On the down side, though, a surprising number continue to recommend companies right up to the day they file for Chapter 11.
The study, from Weiss Ratings, examined 30 brokerage firms and their recommendations on 18 companies that went bankrupt between September and December 2002. At the time these companies filed for Chapter 11, brokerage firms had issued 55 individual buy, hold or sell recommendations. Thirty of those 55 were sells.
Though these statistics do not speak particularly well of the ratings’ usefulness, they do represent an improvement. Earlier in 2002, less than 10 percent of all bankruptcy-day ratings were sells. Further, the percentage of firms maintaining buy or hold ratings on the day of Chapter 11 filings dropped to 66 percent from 74 percent early in 2002. Martin Weiss, chairman of Weiss Ratings, says the increase in sells is a "positive sign," but he remains skeptical of the firms’ behavior once regulatory attention wanes.
The study covered many of the biggest brokerage firms, including Deutsche Bank, Goldman Sachs, Lehman Brothers, Merrill Lynch, Morgan Stanley and UBS Warburg. Problems with how firms rate equities came to the fore last summer when a bevy of high-profile analysts—Henry Blodget, Jack Grubman and Mary Meeker prominent among them—continued to recommended companies even as they plunged towards insolvency. The resulting investor lawsuits have caused the firms to reevaluate their ratings procedures.
Several have unveiled new ratings processes, promising a renewed focus on systematic and qualitative research methodology:
* In May Charles Schwab unveiled new Schwab Equity Ratings, a system that aimed to "demystify the investment selection process." Twenty-four research categories (including fundamentals, valuation and risk) are considered before a stock receives a rating. The methodology balances the distribution of ratings, with the top ten percent garnering A rankings and the lowest 10 percent an F.
* On January 13, UBS Warburg’s equity research division announced an effort to provide "greater clarity and detail" in its recommendations. The firm’s buy, neutral and reduce recommendations are now coupled with a predictability rating of 1 or 2. The numbers refine an analysts’ confidence in their price target. With a buy1 recommendation, for instance, the analyst believes there is a high probability the stock will have a return greater than 15 percent. A Buy2 rating indicates lower predictability of that return.