Will Wall Street analysts turn apologetic?

Summary:After-the-fact downgrades are a Wall Street staple, but one analyst delivers a rare mea culpa with his downgrade of Exodus.

Wall Street analysts are known for a lot of things--being too optimistic, failing to warn investors about the dot-com crash, and being the latest target for Congress--but they usually aren't known for their apologies.

After Exodus Communications' profit warning last week, a slew of analysts downgraded the company even though they touted the stock as it plummeted from a split-adjusted March 2000 high of $86.65 to $2.

After-the-fact downgrades are a Wall Street staple, but one analyst delivered a rare mea culpa with his downgrade.

Morgan Stanley analyst Jeffrey Camp cut Exodus to a "neutral" from "strong buy" and gave his clients an apology.

"There are few moments in my career that rival this one in its difficulty and unpleasantness. Elbert Hubbard said, 'The line between failure and success is so fine, we scarcely know when we pass it.' But passed it I have, and it is time to own up," Camp said.

"We are downgrading our rating on Exodus from 'strong buy' to 'neutral.' Part of the difficulty in this decision rests on the muddled fundamental picture, where we do not have a clear view of whether the outlook is improving or deteriorating. If it is improving, surely we are downgrading the shares at the bottom, but if it is deteriorating, better late than never," Camp explained.

The timing of Camp's apology was hard to ignore since analysts are taking heat from legislators, the press and industry trade groups. Earlier this month, Congress held hearings about conflicts of interest for Wall Street analysts. Meanwhile, the Securities Industry Association issued a set of " best practices."

U.S. Rep. Richard H. Baker, R-La., the chairman of the House Subcommittee on Capital Markets, recently said he was "deeply troubled by the evidence of the apparent erosion by Wall Street of the bedrock of ethical conduct."

Analysts have noted in the past that they blew it with their predictions, but it's usually noted with comments such as "belated downgrade" and "we wish we would have made this call earlier."

Was Camp's apology a response to the feeding frenzy surrounding sell-side analysts? Or was he just being a stand-up guy?

Camp didn't return phone calls for comment, but analysts said he just put in writing what tends to occur behind closed doors with clients. "There have been many times in the past where you have to apologize to clients," said William Blair analyst Abhi Gami. "If you have success 60 percent of the time, that other 40 percent means you're sometimes handing out apologies."

Gami said institutional investors, the clients who were receiving Camp's research note, take bad calls in stride. Individual investors, however, are irate because they've lost money by listening to analysts.

For sell-side analysts, the goal is clear: Be right more than you are wrong. You can have a career on Wall Street being right 51 percent of the time, but you can have a really good career being right 60 percent of the time. Simply put, analysts will botch predictions--it's part of the business.

Derek Brown, an analyst at WR Hambrecht, said there will always be missed calls, but investors will only remember the bad predictions. Brown's recent bad call was VerticalNet. He stuck to a "strong buy" rating as the stock was halved from $10.93 to $5.31 in December. On Dec. 20, he cut his rating to "buy" after the company transformed its business and sold its electronics component exchange.

On Jan. 8, Brown cut the company to "neutral" after well-regarded CEO Joe Galli left the company and it became clear VerticalNet was a major turnaround project.

Brown acknowledges that he could have saved his clients some money, but also noted that his "buy" rated stocks are up at least 30 percent for the year.

But most folks only remember the bad calls, analysts say.

Manuel J. Recarey, an analyst with Fahnestock & Co., was one of those analysts last week doling out downgrades to Exodus. He said he was surprised by the problems the company had.

To make matters worse, Recarey had Exodus on his radar but didn't pick up coverage because the stock looked too expensive. Only when shares hit about $5 did Recarey think it was safe enough to start coverage with a "buy" rating. That price turned out to be too much, as he cut the stock to a "hold" after Exodus' profit warning.

"I didn't expect the deterioration in the business," he said.

Should Recarey apologize like Camp?

"I don't see that as a big trend. People will always say, 'You should have downgraded it,'" he said. "Our job is to predict the future and be right all the time. It's not easy. Sometimes your calls work out and sometimes they don't."

Topics: IT Employment

About

Larry Dignan is Editor in Chief of ZDNet and SmartPlanet as well as Editorial Director of ZDNet's sister site TechRepublic. He was most recently Executive Editor of News and Blogs at ZDNet. Prior to that he was executive news editor at eWeek and news editor at Baseline. He also served as the East Coast news editor and finance editor at CN... Full Bio

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