If you thought stock research was simple and transparent in the wake of Eliot Spitzer's crusade, you haven't looked closely at Wall Street's new rating systems. While all the major investment banks now adhere to a three-tier system to classify stocks, no standardized rules have been adopted, meaning that each brokerage has been able to define buy, sell and hold in its own unique way. "Companies have a right to rate stocks any way they want, but they also have a responsibility to provide a common denominator so we can compare them," said Thomas White, managing partner of Best Independent Research.
To make matters more confusing, UBS recently started rating its price forecasts separately, assigning a 1 rating to a price target that has a high probability of being met and a 2 rating to targets that could potentially be way off the mark. Over at Lehman Brothers ( LEH), ratings are assigned in an entirely different way. A buy rating, or overweight as they like to call it, means simply that a stock should perform better than the average stock in the analysts' coverage universe, according to a spokeswoman. In that case, investors would need to find out how the average stock had performed before acting on the advice. Lehman analysts also rate the attractiveness of their respective sectors.
Double TalkAt Merrill Lynch ( MER), a buy rating on a stock with low or medium volatility suggests a return of 10% over a 12-month time horizon, while the same rating on highly volatile stocks implies a 20% return, including dividends. Stocks rated neutral are expected to gain between nothing and 20% -- depending on the level of risk that Merrill deems them to have -- while stocks labeled sell are seen producing a negative return. But at UBS Warburg ( UBS), a buy rating suggests that a stock will gain 15% or more over the next 12 months, including dividends, while a neutral rating implies a return of 15% or less, with the potential to decline as much as 15%. If UBS analysts slap a reduce rating on a stock, they expect it to fall by 15% or more. All of the firm's recommendations are determined by the analysts' target price.
"It made for great P.R. to go to a three-point system, but everyone's interpreted it in a different way," said Kei Kianpoor, CEO of Investars.com, a Web site that tracks analyst research. "Investors shouldn't need a degree in deconstruction to understand what a buy means."