Rigor of Wall St. Analyst Reports

[jschembs]

In my opinion, the rationales given to support price targets among Wall St. equity reports border on comical. Below are two valuation summaries from Goldman's Heather Bellini (a fellow CFA charterholder, regretfully) regarding Salesforce.com (CRM). The first is dated Aug 4, after their ExactTarget (ET) acquisition, while the second is dated Jun 4 (prior to the acquisition). CRM's acquisition of ET increased CRM's future GAAP losses - nevermind the cost to acquire those GAAP losses - so Heather simply bumped up her assumed multiples to back into her existing $60 target. She claims the higher multiples are warranted given higher assumed revenue growth post acquisition. ET has not generated any free cash flow over the last five years, so I'm not sure a higher FCF terminal multiple is necessarily warranted. Further, and this brings up a much more interesting point, how can she justify the same 9% discount rate after acquiring a much riskier business AND after a 100 bps increase in the 10-yr treasury, which should absolutely affect the rate at which highly unpredictable future cash flows are discounted? I realize the 10-yr is up only ~50 bps from early June, but her other CRM reports earlier in the year also use a 9% discount rate.

 

Aug 4 Valuation Rationale

 

Our 12 month price target of $60 is unchanged and is based on an equal weighting of our DCF, EV/bookings and P/CFO analysis. Based on a CY14E P/CFO multiple of 38X (from 35X prior) we derive a valuation of $57 per share. For our EV/bookings analysis, we arrive at a value of $67 based on a 7X multiple of our CY14 estimate. Lastly, our DCF assumes a 9% discount rate and a 26X terminal FCF multiple (from 21X prior), suggesting a valuation of $56 per share. This implies a perpetuity FCF growth rate of 5%. We have slightly adjusted our valuation multiples given our view on better top-line and booking growth post the acquisition of ET.

 

June 4 Valuation Rationale

 

Our 12 month price target of $60 is based on an equal weighting of our DCF, EV/bookings and P/CFO analysis. Based on a CY14E P/CFO multiple of 35X we derive a valuation of $59 per share. For our EV/bookings analysis, we arrive at a value of $65 based on a 7X multiple of our CY14 estimate. Lastly, our DCF assumes a 9% discount rate and a 21X terminal FCF multiple, suggesting a valuation of $57 per share. This implies a perpetuity FCF growth rate of 4%. Risks to our call include an unforeseen macroeconomic slowdown impacting the IT spending environment broadly, higher expense growth driving pronounced margin compression, and weak sales execution as new reps take longer than anticipated to become productive.

[JBird]

Hahaha

[Morgan]

Well, I'm just a young guy with no Wall St. experience, but I'll say she is probably a very intelligent person considering she works at GS and has a CFA. Perhaps not, but probably. That said, she operating in a system that has incentivized her to write anything to help sell products. Her incentives are aligned with her employers other business operations. Also, if anyone gives her or GS trouble they can say it is her opinion, not fact.

 

Look at incentives, opinion vs. fact and always do your own research. You probably know that though.  ;D

 

But yea, kinda silly sometimes lol

[fareastwarriors]

From the buy-side, the word on the street is the estimates/target prices are garbage. The buy-side like the sell-side's industry data/competitors as well as connections/access to management. Some analysts are better than others. Buyers (users) beware.

 

[Phaceliacapital]

Agree with the above, sell side research has excellent industry/market research that would otherwise take me days to compile (I sometimes pity the young IB'er that finishes this material at 4 in the night) concerning competitive/regulatory landscapes, market research where they for instance go to China and ask local bypassers what kind of luxury products they're buying (let me tell you, it's not LVMH) etc etc..

 

In terms of rationales to buy the price, unless it's a turnaround story I mostly don't really pay attention to what they are writing. But yeah, you can't earn commission on a "Neutral/Hold" and they typically have 12-18 months horizons.

 

That's sometimes even funny because they go like, yeah you should sell it now and buy it back after Q2 results because the rain will cause a 50bps decline in their EBIT margin and will be unfavorably looked at by the market.

And then I go like: But what if I like it as a Long term investor? Their reactions are sometimes quite surprising :D

[Guest wellmont]

$crm does a lot of banking business with wall street. huge amount. therefore it makes a lot of sense for a GS analyst to write favorable things about $crm. She's probably a pretty smart analyst. But she knows where her bread is buttered. I rarely use sell side reports. when you listen to sell side on cc, they ask questions that help them write their reports. they don't ask questions that an owner wants answered. they ask about minutiae. What's refreshing is to hear Leon Cooperman get on a call. You can instantly tell he is not a sell side analyst. and he asks questions that owners would want answered.

[xtreeq]

Well, I'm just a young guy with no Wall St. experience, but I'll say she is probably a very intelligent person considering she works at GS and has a CFA. Perhaps not, but probably. That said, she operating in a system that has incentivized her to write anything to help sell products. Her incentives are aligned with her employers other business operations. Also, if anyone gives her or GS trouble they can say it is her opinion, not fact.

 

Look at incentives, opinion vs. fact and always do your own research. You probably know that though.  ;D

 

But yea, kinda silly sometimes lol

 

Read the CFAI Code of Ethics and Standards of Professional Conduct:

 

http://www.cfapubs.org/doi/pdf/10.2469/ccb.v2010.n14.1

 

... and you will better understand that she is very likely NOT living up to her obligation as a Charterholder ... classic Standard I(B) and V(A) failure IMHO

[jschembs]

Great point xtreeq. As a charterholder since 2006, I shudder when I see CFA behind any Wall St. analyst publishing research conclusions such as this.

[Shane]

The rational might be weak, however, the rigor of the research I think is very in-depth.  As was mentioned above, they are incentivized to change their recommendations frequently.  Also, the majority of their clients want to be in and out of stocks, not long-term holders.  So a buy could probably be read "trading buy", rarely are they thinking more than a year out.

 

I meet with sell side analysts all the time and am consistently impressed with their depth of knowledge.  I am also baffled by their inability to translate that into an 'investment' recommendation that I can use.  The mindset is different.

[xtreeq]

I just passed L2, and I got over 70% on ethics on both levels, even though most retakers of L2 would swear that June 2013 ethics was very very difficult ... I take it seriously ... but if it gets to the point where investos (like people on the board) openly ridicule Charterholders  (see the hahaha response earlier in the thread) and have zero faith that the holder of the designation ACTUALLY upholds himself to a higher stndard (if the logic is weak then there is no reasonable support for the reccomendation and it should not be issued and the Carterholder should dissociate her/himself from it!), then I believe the CFAI is FAILING in its core mission ... it saddens me

[LC]

My perception of the CFA is that, like most designations, it is not a replacement for wisdom, experience, and morals.

[bookie71]

My perception of the CFA is that, like most designations, it is not a replacement for wisdom, experience, and morals.

It's probably a lot like my C.P.A., it means I was good at taking tests. 

[Otsog]

The CFA teaches EMH and TA, I wasn't aware anyone took it seriously in the first place  ;)