WFU Law School
Law & Valuation
4.3.2 Basic Stock Valuation

4.3.3 Stock Valuation Experts (Role of Stock Analysts)

[Role of stock analysts]

Following the accounting scandals at Enron and other companies, the research departments of Wall Street's biggest firms came under intense scrutiny for the fialure of their analysts to discern the accounting frauds. Analysts who followed the high-tech sector have also been criticized for failing to predict the technology-stock collapse.

Many have asserted that the failure of "analysis" was due to conflicts between investment firms' analysts and investment bankers. That is, the analysts gave overly rosy predictions of company prospects to bolster the firm's interest in corporate finance work with the companies.

For example, analysts at Salomon Smith Barney kept "buy" recommendations on Enron stock even as the company fell into bankruptcy. See "Wall Street Analysts, Vilified, To Get Stricter Regulations" WSJ 02/07/02.


STUFF HERE ABOUT THE CREDENTIALS OF A STOCK VALUATOR

Beware the Source of Your Stock Tips

While there is no one out there who can consistently give you great stock picks, many so called "stock tipsters" make much money based on "hot tips." However, these tipsters have a similar reputation as used car salesmen. Completely bogus tipsters were common during the bull market of the 90s.

In the 03/13/00 Time article, "Taking Stock Scams Off-Line", a scheme hatched by a group of Georgetown law students is detailed. One student attracted a few thousand subscribers to his bogus site, Fast-Trades.com. Here, the student issued stock picks and identified four penny stocks as hot. Previously, he and some classmates had purchased thousands of shares of these four stocks. Next, the students used web aliases to post hyped and misleading messages that recommended the stocks. Many investors loaded up on these stocks, and one of the them, American Education Corporation, rose 700%. Before reality set in, the students had sold their shares, executing a classic "Pump and Dump." The group, which included one of the students' mothers and member of the Colorado Springs city council, was caught by the SEC, but thier story is played out quite often. The best thing to remember is that if a tip sounds just too good to be true, it more than likely is.

Irrational Exuberance

The late 90s astronomical valuations of some high-tech companies suggested that stock analysts can stray (badly) from DCF. In April 1999, AOL was selling at 700 times its earnings, assumed a "sky is the limit" growth potential. It defied all conventional valuation logic.

At the time Fed Chairman Alan Greenspan admonished investors against "irrational exuberance." Greenspan looked wise when, during 2000, the bubbles of many stocks burst. For example, Globe.com went public in 1998 and had the largest one day price leap in history. In 2001, the stock was pulled from the NASDAQ market listings because its price was too low. See

  • "Web Tide: Initial Public Offerings Aren't the Same in Era Of Internet-Stock Mania" WSJ 01/19/99
  • "Poster Boys: After the Soaring IPO And the Fleeting Fame, A Question: What Now?" WSJ 05/02/01.
 

Student papers

For an interesting look at Netscape's IPO process, see Steven Freitas, Pricing Netscapes' Initial Public Offering in the Context of the Legal Responsibility of Investment Banks.

On a related subject, see a student paper on the increasing liability investment bankers face in the context of mergers and acquisitions and the use of fairness opinions to minize potential liability. Drew Patten, Investment Bankers, Managers and Company Shareholders.

4.3.2 Basic Stock Valuation

©2003 Professor Alan R. Palmiter

This page was last updated on: August 5, 2003