Analysts Say The Darndest Things

After the dotcom crash earlier this decade, where we watched the Nasdaq Composite Index drop 78% in the span of 18 months, Wall Street attempted to separate equity research from investment banking in an effort to provide so-called independent analysis

This analysis was supposed to be free from any conflicts of interest that an existing investment banking relationship creates. Instead, two things happened: first, independent firms like Jennifer Black & Associates sprouted providing impartial and unbiased research to institutional investors, and second, equity analysts became part-time linguists, trained in the subtleties of the English language. (For more on stock ratings, see Stock Ratings: The Good, The Bad And The Ugly.)

What emerged is a system predicated on sitting on the fence and covering one's butt, if you'll pardon the mixed metaphor. When analysis involves playing it safe, no one wins. At least when infamous internet analyst Henry Blodget was hyping stocks, investors had the opportunity to tell him (through their actions) he was full of you know what. How is today's gobbledygook any better?

Recent Downgrades
Here are three recent examples of analyst downgrades and some commentary that came with those demotions:

Buckle (NYSE:BKE)
JP Morgan analyst Anna Andreeva downgraded the Nebraska teen retailer to 'neutral' from 'buy'. She wrote, "While we don't expect margins to collapse when [same-store sales] do slow given low overhead and lean inventories, at 20%, Buckle's margins are the highest in our universe, very impressive for a retailer selling third-party brands ...We think further upside would be tougher to come by as the company laps several years of merchandise margin expansion."

Translation: We have no idea how Buckle keeps doing so well. It can't possibly keep this up. We'll play it safe and drop Buckle to neutral just in case. But we really like them.

Note: Buckle actually sells its own private label brand BKE in addition to third-party product. In fact, the latest 10-K shows BKE contributed 30% of sales. That's hardly insignificant and a major reason for its margin expansion.

VF Corp. (NYSE:VFC)
Lazard Capital Markets analyst Todd Slater lowered his rating on the apparel maker to 'hold' from 'buy'. He wrote, "VF was not getting credit deserved for its management talent pool, its penetration into the trending contemporary market, its international diversification, and its more assertive posture on building out retail, moves that each carried the promise of accelerated revenue growth and higher margins ... We believe it is prescient to take some chips off the table and wait for an attractive entry point ... It is a "best-of-breed" branded apparel operator."

Translation: Even though we love this company, its stock is up 20% year-to-date in a terrible economy. The good times have to end. Rather than tell you to outright sell, we'll tell you to hold while also suggesting you some take chips off the table, making us right no matter what you decide.

Chico's FAS (NYSE:CHS)
Piper Jaffray analyst Neely Tamminga recently downgraded the Fort Myers-based women's retailer to 'neutral' from 'buy' stating, "While we believe Chico's is on the right track to tighten inventory levels, reduce controllable expenses and regain traction in their once-industry-leading operating margin levels, we believe the overall environment is worsening and causing a bit of a delayed timetable to Chico's recovery."

Translation: The economy sucks. Chico's turnaround will take forever. We're only covering the stock because it once was relevant in retail.

Note: The analyst, in addition to the downgrade, lowered Chico's target price to $7 from $9. Given it's currently trading in the $5 range, shouldn't it still be a buy? (To learn more, see Target Prices Vs Ratings.)

Bottom Line
Placing your bets based on the words of analysts, who now more than ever, will be scared of screwing up, can only lead to failure. It's important to remember that these chartered financial analysts are paid to provide analysis to institutional buyers. Those buyers use this information, not to sway their opinion, but rather to generate possible investment ideas. I'd be shocked if any investment manager worth his salt has ever relied on the words of those who are merely marketing pawns in a system gone terribly awry. Caveat Emptor.