Often young and mostly inexperienced, they can make or break a company. Christopher Blackhurst.
Ask Richard Branson about City analysts and the famous smile temporarily fades. Sitting on the sofa in his Holland Park home in London, Britain's highest-profile multi-millionaire claims that if he had listened to them his Virgin empire would not be the force it is today - and it goes without saying, he would not have been so wealthy.
"They advised against opening Virgin in Japan, the US and expanding abroad. And there is no way they would have allowed an entertainment group as a public company to have launched an airline."
"They" are the 1,600 investment analysts working for City broking firms or banks, such as James Capel, SG Warburg or Kleinwort Grieveson. They quite literally immerse themselves in every detail of a clutch of the 2,000 quoted companies in any one of a number of industrial sectors ranging from electronics to retailing or banking. In essence, their job is then simply to use their expertise to advise both their clients (pension funds and the like) and their own sales staff on prospects of the company they follow, tipping which shares to buy and sell and when.
Through the '80s, the City analysts truly arrived in the public psyche. As financial news assumed a new importance (with wider share ownership and privatisation pushing the number of small shareholders from around three million to some 10.4 million during the decade) it became de rigueur to have analysts on television news with a handy sound-bite. City news pages were also not complete without a pithy comment from an analyst prognosticating one of his companies.
With public prominence came, of course, a degree of opprobrium at their earnings. Six-figure salaries, coupled with a champagne-and-Porsche lifestyle which had a hypnotic attraction for the tabloid press, did little to endear the profession to the public. Indeed, Nigel Lawson earned some all too rate public approval when in 1988 as Chancellor, he dispragingly referred to one particular group of City analysts, the economic forecasters, as "teenage scribblers". This view was widely shared in industry and the business world and not just by mavericks like Branson. Speaking in 1990, Amstrad boss Alan Sugar, claimed: "There should be some professional team for these analysts. Most of the time they talk through their backsides." And writing in his autobiography, George Davies, the former Next king, said: "Most analysts remind me of the old bookies runners."
Even the Bank of England felt sufficiently concerned to fire off a broadside over the role of analysts. Last October, one of the bank's more senior executives, associate director Pen Kert, savaged analysts. At results presentations," he said, "analysts often fail to ask intelligent or penetrating questions. Analysts have to be spoon fed."
There was more. On their own, company accounts - the analysts' major tool - were not enough to put together a picture of a company. Their users "must be disabused of the notion that financial reporting is an exact science".
For Branson, and many industrialists, the analysts' obsession with short-term gain is particularly soul-destroying. "It infuriates me ... During the late '80s they made the very big mistake of getting carried away with companies on the acquisition trail and paid little attention to companies like ours built from scratch." It is easy, he continues, "to do a takeover, bump up profits and to do the same the following year. The analysts encouraged it. But while that was going on, companies like ours were getting a raw deal. They just weren't interested. What they forget, of course, is that the future has to be those that build from scratch and don't keep closing places and laying-off staff." In the end, after two years of responding to analysts, Branson took Virgin private again in 1988 in a £93-million deal. "One of the things being a public company takes away is freedom - usually something so important that in history people have gone to war for it. We now have the freedom to do things long-term and make decisions that we think are best, not the City."
From an analysts' perspective, the short-termism that Branson et al bemoan is a product of the ruthless competition for business, particularly in the aftermath of the October 1987 market crash. In 1989 there were some 2,000 analysts in the City, and a year later, the number had only fallen to 1,900, despite dire warnings at the time that there were at least 50% to many analysts. Yet the amount of business in the City had fallen sharply, from a peak of just under 13 million share trade bargains in 1987 to 6.3 million in 1990. Since them trading volumes have shown slight improvement, to 7.5 million in 1991, yet the numbers are still far in excess of the ideal level of 1,000 analysts that the City could handle.
With limited job security and employers who frequently lose large sums of money (James Capel, for example, produced losses of £30 million in 1990 after a miserly profit of £358,000 in 1989) the analyst's main motivation is to drum up business and make a name for himself.
Both traits are hardly conducive to long-term thinking as Swraj Paul, the chairman of Caparo Industries found. A well-run steel and engineering group, Caparo enjoyed several years as a quoted company, but Paul grew increasingly impatient with analysts who had little time for Caparo, preferring to concentrate on bigger companies, where they could generate larger commission for their firms on larger transactions. There were some very good ones," he says, with deliberate emphasis on the word "some", "but basically, all analysts are interested in is the current year and the next year, beyond that it becomes too difficult for them to grasp. We were operating at a different time-scale. We were looking three years ahead and making three-yearly plans." No matter how hard he tried he could not get analysts to take his successful but unfashionable business seriously. Like Branson, he decided to take Caparo private in a deal that valued the whole group at £59.4 million. "We were always saying to them, "Look, we're an interesting company, why not come and see us?" But they didn't want to know.
Branson and Paul were lucky. They had the private means and the track record to be able to buy their businesses back. But many are not so fortunate. They must try and work with the City, establishing investor relations departments and running elaborate programmes to keep the analysts informed. They meet them regularly as a 30-50 strong pack, professionally and socially, laying on company visits for them, often as not, providing a worldwide tour of operations. Yet for all this effort, their shares can be marked down at the slightest whim or rumour. One leading industrialist maintains how he felt betrayed "by one analysts who had been to see him to talk about the company, who hadn't even left the local railway station before he was on the phone telling his salesmen to sell."
There is also the tale of an FT-100 chairman calmly answering the questions of a young analysts, and growing more irritated by the implied criticism of his management style. Eventually the chairman simply had enough and abruptly terminated the interview, throwing his 25-year old visitor out with words to the effect, "I run a profitable business and yet you are coming here to tell me how to do it from a bank that lost £500 million last year. Get out ..."
For many this proves that analysts are a law unto themselves. Judged only by the commission they can generate, it appears they can cover their chosen sector in any way they see fit. They don't have to sit exams or even to have worked in industry. (Only the Society of Investment Analysts requires them to sit exams and most analysts choose not to join.) Yet, they have the power to make or break a company. Just what sort of people are they?
Young and confident (average age, 34), they have little knowledge of life beyond the City. One analyst gives the breakdown of his colleagues: 30% are ex-accountants; 30% have worked in industry in some capacity and 40% are graduates who either joined straight from university or worked elsewhere in the City first.
Yet they are courted by fund managers, their own colleagues and the media for their opinions. The best of them can earn £300,000-plus a year. More likely a £60,000 to £70,000 basic salary may be doubled by bonus, making £150,000 a year not untypical for those working for the blue-chip brokers such as S G Warburg, BZW, Phillips and Drew or James Capel. Though recession has clipped their wings, the top analysts earn more than many a chairman of a small or medium-sized engineering company.
There are now hard and fast rules about how the pay packet and bonuses are calculated. Three main criteria are taken into account: the volume of trades generated by the analysts and his sales team in the year; clients' views; and the Extel survey. Together they give a firm a pretty good idea of how valuable the analyst is and what they should pay him.
The point about these deliberations is that they take little account of the accuracy of individual forecasts. An analysts can be hopelessly wrong but still suffer no drop in pay. "We can be out by 10% and nobody will mind at all," said a James Capel analyst. "More important is what the client tells the firm about us - whether it likes us or not and what it thinks of the words we produce."
Market share is crucial. If a firm raises its proportion of electronics share trades, say, in a year, the electronics team of salesmen and analysts will almost certainly have their bonuses increased. Conversely, if the share falls, they will be slated and their bonuses will be cut.
Some clients, such as Schroders, operate a six-month rolling review of their investment houses. Schroders will tell the firms how much business it intends to put their way in the coming six months and why.
If the analyst appears regularly on TV or in the press, and gains subliminal advertising for the firm, he will be rewarded accordingly. The effect is to encourage self-publicity and media attention.
As a result, says Roger Young, director-general of the British Institute of Management and himself a former analyst of the old school: "Much of their work is superficial - they simply don't understand what business is about." As for their company reports of which they are so proud, Nigel Taylor, head of investor relations at ICI says: "They produce too much paper, a lot of which is reproduced and most of which gets dumped." Even the people analysts are directly meant to serve - their clients are dissatisfied. In the 1991 Extel ranking of analysts (the annual test that can make or break an analyst) which is completed by fund managers, almost half of the 1,600 analysts obtained no votes at all. If that is not bad enough, fund managers were asked for their attitude to analysts' work. Some 60% said they do not read three-quarters of the research material they received. According to Geoffrey Osmint, the survey's founder and consulting editor, City analysts these days means a lot of wasted time, money and paper. "One major research broker alone estimates that it sends nearly 1,500 kilogrammes of research material each week to its clients. Compounded by all the research output from the City that could mean 30-40 tonnes of paper is shipped each week to investment managers."
Osmint started the survey almost by chance after joining Continental Illinois, the US bank, in London in 1973. He had two mandates: to establish a Eurobond operation and set up an investment management arm. Before committing the bank's business he decided to examine the research on offer. "I thought it would be useful for our investment managers to put our heads together and see what we thought he recalls. The annual ranking survey was born.
Analysts themselves accept that much of the criticism is justified. "Not many of us know how to communicate or to get on with the people we are writing about. So much of what we do should be about simple common-sense," says one retail watcher. And a top aerospace analyst commented: "I'm very conscious people regard us as spivvy and short-term; long-term credibility is vital. Not enough of us build up a rapport with people on the outside ..."
Yet the criticism of analysts is a recent phenomenon. In the '60s analysts as we recognise them today were a rarity. "Only a handful of stock-broking parlours," says Osmint, "had realised they had an asset on their hands that they were not using." At those firms, he says: "Researchers, as they were then called, were encouraged to come out of the back-room and meet people." They were allowed to compile reports on companies and make recommendations to clients. The majority of firms, though, stick to the traditional approach. There, "analysts, who were usually called statisticians, remained poorly-paid and in the background. It was left to the partners to write up the research and investment ideas."
Osmint's survey coincided with the emergence of the new professional analysts. Initially, they proved their worth. For example, long before the collapse of Rolls-Royce in 1971, Gerald Kelly of Rowe Rudd said the shares were a "sell" at 75 shillings. When they fell to 50 shillings, he repeated the advice. When they reached 25 shillings, he still said "sell". Not once did he change the tack to a "buy". He was proved right when Rolls-Royce was forced into bankruptcy and had to be secured by the Heath government. "The fact was", recalls Young, "he had foreseen what was going to happen before anyone else."
"Analysts came out in the bull market of the early "70s," says Young. "It was then that you started to see people specialising in individual sectors." For the first time he recalls, "there were really analysts and salesmen". It was a natural split. Analysts were thinkers, salesmen haggled over prices; analysts were graduates, salesmen were school-leavers.
There was mutual respect between the two. Analysts studied companies and sectors in-depth and passed on advice to the salesmen. From the outset, says Young, some researchers stood head and shoulders above the rest. "Wood Mackenzie started producing tonnes of well-researched material, mostly about companies the Scottish firm knew something about, like Distillers, Burmah Oil and House of Fraser, "he says. "Fund managers had no time to read it all but they could read the executive summaries and look up the bits they wanted to." Others began to copy the Woodmac approach with varying degrees of commitment and success.
In a City that had not yet succumbed to the mid-80s cult of personality, the stockbroker was still king. From the start, though, analysts still remained low-profile and low-paid. The turning point came with the run up to Big bang in 1986.
In the early '80s, the City exploded. Partnerships disappeared as firms scrambled to sign up with a bank ahead of deregulation. For both foreign and British banks with fat cheque-books, money was no object. Barclays, for example, paid £120 million to acquire both broker, de Zoete and Bevan and jobber Wedd Durlacher in 1986. In the same year, Kleinwort Benson paid £44 million for Grieveson Grant.
Top of their shopping list was research. US banks in particular had always put a heavy premium on research and good analysis. "American analysts always seemed to have a remarkably deep knowledge of one small area. As a result, their work was better. They had a tremendous depth of knowledge," says Douglas Hawkins, a former star-rated electronics analyst at James Capel who went off, unusually, to run a business, giving him a unique insight into both sides of the fence. He recently returned to the City as new telecoms supremo at Smith New Court.
The biggest contrast, he says, as the difference of scale. "As an electronics analyst I was looking at very large organisations and acquisitions. I was constantly dealing with the big picture. But suddenly I was running a small company with small problems." The experience, he says has made him a better analyst. "It is possible to learn the big analytical issues from textbooks. But running a company taught me all about the vital things that aren't in text-books, like cash generation. The religion of analysts is the P/E ratio - the whole market is geared to it. But a more real measure of how well a business is going is its return on capital and how much cash it generates. It has certainly changed the way I look a things now."
In Britain, experienced analysts could command six-figure sums to move - or to stay - while novices barely out of university were signed up as stars of the future. Starting salaries of £25,000 for fresh-faced, 21-year-old graduates with the promise of much more to come, were not uncommon. Research teams no longer appeared to work for their employers but for themselves. Hardly a day went by without Carol Leonard City Diary in The Times gushing about yet another en masse defection or poaching.
Says Osmint: "there is no doubt that it was at Big bang when the quality of research suffered. The people being recruited had no experience or training. "Suddenly, there were 50 or so analysts covering a sector, all desperate to make a name for themselves and justify their huge salaries.
Prior to Big bang, analysts, tended to be studious types. But these characteristics do not tally with the qualities that make a good analyst. When fund managers were asked by Extel to list them last year, the vast majority gave priority to two categories: knowledge of industry, companies and management, and depth and quality of research. Other attributes like communications skills and helpfulnes came nowhere.
Success does, however, have its price for the individual analyst. Since Big bang, analysts have come under enormous pressure from employers to translate their work into share trading. The conflict between producing good, accurate research or something that will encourage a client to trade, is growing.
Last year, Jill Johnson, the 32-year-old number two ranked food retailing analyst, resigned from UBS Phillips and Drew. Johnson, who was poached from James Capel in a two-year contract reportedly worth £500,000, highlighted the flaw in the new post-Big bang approach. "I'm fed up with broking," she said. "It has stopped being rewarding. Your number one priority has to be build market share but if you are a analyst you also want to get it right and those two aims are not always compatible. If you are going to get your recommendations right, you have to advise on timing as well and that may mean that you do no business."
Analysts have become pushier. Less interested in the intricacies of the business they are writing about than their older counterparts, they are gripped by ideas to sell to clients - ideas that inevitably involve takeovers, speculative stakes and baffling jargon. Says Young: "I remember standing in the loo at a party with an industrialist who turned to me and said, "Roger, what's this P/E thing they're talking about?" I replied - it was the old earnings yield. "So why don't you just say that?" he asked."
Young, who does not doubt for a minute that "analysts are a good thing because they impose a discipline on companies to maintain shareholder awareness," also argues that they have a lot to answer for. The "most common beef", he says, "is the poor quality of analysts and their lack of understanding of the realities of the real world."
At ICI, Taylor complains that 80% of the research produced on the company is "me-tooish" - poor quality and unoriginal. ICI goes out of its way to take the 45 analysts who follow the chemicals giant in the UK on plant visits. "These guys are often not exposed to industry," he says. "We find that if they are just working on figures, its difficult for them to associate with the stuff on the ground."
Chemicals analysts need ICI without it there would hardly be a chemicals sector to speak of - but equally, says Taylor, ICI needs them. "Around 2,000 institutions in the UK hold ICI stock. We would love to meet them all but there is only so much we can do. Analysts do it for us." Plus, he says; "Every day, there are rumours rattling round. Institutions go to their analysts who can either give an answer then or ring us up and ask."
But until the system is reformed the industry-analyst relationship will remain unharmonious. Mandatory exams - which would go some way towards achieving a degree of consistency - less pressure to appear on TV or in the press and less published research, would all help.
In the end, though, only two things would really solve matters: fewer analysts and time out in industry. The latter, says Young, would quickly teach analysts how stupid some of their queries sound. "They forget that year-end adjustments can swing a margin by a point or two. For example, they go round a factory and expect a manager to know precisely what his stock position is going to be at the year end. He can only give them an estimate, not the final physical number. Then, when the final figure comes out worse, they are disappointed and mark the company down." If Young had his way, every analyst would be required to spend a year working in industry. "It would be tremendous. It would fire them with enthusiasm and give them an immediate understanding of how tough life is out there. It would improve their communications skills enormously." And he adds: "What the City fails to realise is that people who talk the same language get on better."