Why Investors Pick Thinkers Over Stock Pickers

Are the analysts that managers like best also the best stock pickers?

The answer is a resounding "No."

In our Analyst Rankings -- Equity 2000 survey, we polled institutional money managers about their favorite analysts. We also rated the analysts on their success at picking stocks. (See our methodology.) Each analyst got both a voting and a stock-picking score, which could total a maximum of 100 in each category.

But few of the analysts who topped the voting came anywhere near the top in stock picking. The 63 analysts who received the top score in stock picking earned an average voting score of a measly 18. And analysts who were held in the highest esteem by institutions -- boasting a perfect voting score of 100 -- had an average stock-picking score of 66. No great shakes, especially when you consider that 66 is the average stock-picking score of all the analysts we ranked.

What Makes a Good Analyst

So, if money managers don't care about stock picking, what do they prize most in an analyst? Our survey showed that managers are most interested in analysts who make them think.

The Winners

By name By category By firm Best stock pickers Best firms

"What makes a good analyst is not necessarily getting the market calls right. What I find most useful is getting the facts and figures behind the argument because I make my own stock-picking decisions," says Ted Kellogg, portfolio manager at Boston Partners Asset Management. "The thinking of an analyst is far more valuable to me than stock picks."

When asked to rank the analysts they like best on six attributes, our voters gave their favorites the highest marks for "makes me think." Over and over again, in written comments, voters used "ahead of the curve," "good, original insights" and "unique perspective" to describe their top choices.

"She thinks out of the box, in a way that none of her competitors can match," said one voter about an analyst he likes. "If one could quibble, it would be her ratings, but who listens to sell-side analyst ratings anyhow?" (See our related story on the state of analyst research.)

Who's Picking These Great Stocks?

Perhaps the biggest investors don't look to Wall Street for stock picks because they don't know who the best stock pickers are. A number of outstanding stock pickers hail from firms that don't have a huge national presence -- such as Richmond, Va.-based Scott & Stringfellow (Jack Kasprzak, building products); Arlington, Va.-based Friedman, Billings, Ramsey (David Hilal, Internet software and services); and Dallas's Morgan Keegan (David Childe, computer and electronics retail, and Robert Montague in computer storage and peripherals). Lacking a big and aggressive sales force, it's tougher for these analysts to get in investors' sights.

Investors who like conspiracy theories might surmise that the reason the star analysts at the biggest Wall Street houses don't do better at stock picking is because they're interested only in plugging stocks their firms are underwriting. But the data in our survey don't support that idea: The biggest concentration of top stock pickers is at Deutsche Banc Alex. Brown and Donaldson Lufkin & Jenrette. Salomon Smith Barney leads the pack among firms that have analysts with stock-picking scores of 90 and above.

Both Alex. Brown and DLJ say that they have long emphasized stock picking. "We have made it very clear to our analysts that the first thing they want to think about is making clients money," says Dan Khoshaba, Alex. Brown associate director of research. He himself earns a stock-picking score of 84 in the containers and packaging category and takes second overall in that category (and he proudly reports that he now has a sell rating on one of his stocks -- a rare occurrence on Wall Street).

Alex. Brown quantifies the performance of all the stocks that its analysts rate as buys, sells and market performs on a quarterly basis. "Part of their compensation depends on how well they pick stocks," says Khoshaba. "We do not have a formula that links investment banking fees to compensation."

Jack Blackstock, research director at DLJ, also says that the performance of recommendations is factored into his analysts' compensation. DLJ excels at stock picking, he boasts, because it started as a research house and then got into investment banking. "The best hockey players generally come from Canada and not South Florida," he points out. "We view research for the sake of producing research as the primary purpose of our research department."

Several sell-siders argue that sound stock picking is more important than ever. "With the proliferation of distribution technology making maintenance information a commodity, the market for sell-side research has swung to a focus on proprietary research and proactive stock calls," says Jeff Waters, associate director of research at Salomon Smith Barney.

Of course, some of the big-name analysts at big-name firms who were big vote-getters in the TSC survey have absolutely horrible stock-picking records (examples: computer storage and peripherals analyst Rick Schutte, who recently left Goldman Sachs for the buy side, and IT consulting and services analyst David Togut of Morgan Stanley Dean Witter). But if the pendulum is indeed swinging in the other direction, their ratings may not last much longer.