Do analysts play a positive role?

Anup Menon

ANALYSTS have a significant role to play in the Indian markets now than, say, five or ten years ago.

Whether they can ferret out genuinely good stocks or not has been pushed to the background. The focus is on the manner in which companies tend to cosy up to them with information ahead of being made public (to counter such a trend, the Securities and Exchange Commission, US, has introduced the Regulation Fair Disclosure). But is there a positive side to the story?

If we believe that stock markets are efficient, then it means that all available information has been factored into the stock price. But ultimately prices are driven by the market expectations of the company's future prospects. This is where the estimates of analysts play a critical role.

Very often we see headlines in newspapers and the media, which sound like this: ``ABC Corp managed to stage a 50 per cent growth in profits, in line with analyst expectations''. The company may have managed to achieve a 50 per cent growth, but have we benefited from the analyst's insight? This means that the analyst has been able to see through the company and predict its growth rate much earlier.

Valuations in the equity market thrive on future expectations. In other words, an investor with the ability to gauge the future prospects of the company and the industry in general does much better in terms of picking out consistent performers.

If common sense prevails, investors will look to buy those stocks that are trading below their intrinsic value and sell those that are trading above their intrinsic values. If every investor can do this, the world would have been full of millionaires. However, this is not the case. Differences in the fundamentals of different industries and companies make it difficult for an investor to understand valuations of the plethora of stocks floating in the market. This does not mean that investors cannot diversify. Analysts have a major role to play here.

Relevance of analyst forecasts: The value relevance of analyst forecasts can be gauged from their wide following in the US stock markets, which is arguably the most efficient in the world. There has been many an occasion when stock prices in the US markets have been hammered down as companies failed to meet the estimates of analysts. Analysts give their estimates and outlook for the companies in the form of research reports. Since these professionals should have been tracking the stock for a fairly long period of time, their report can be considered an expert opinion on the company's future performance.

Among the advantages that an analyst has over other investors is his better understanding and intricate knowledge of the company and the industry in which it operates. For instance, the valuation technique used for Reliance Industries is different from that used to value Infosys Technologies. Using the same techniques is likely to give skewed results resulting in wrong investment decisions.

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The other major advantage enjoyed by analysts is that they have first hand information from the companies. For instance, corporates normally hold meetings to brief analysts about the latest happenings in the industry. The reason why information is disclosed to analysts is that in developed markets their estimates play a crucial role in the price formation process. It is also advantageous for the analyst as he is in a position to glean potentially important information.

From this perspective we can also view the analyst as an unbiased intermediary between the company and investor. Assume a company has not been doing well in a particular quarter. It knows that sooner or later the analysts will express concern. However, it may be better for the company's reputation if the investors hear about it from the company itself. Therefore, in mature markets, companies give profit warnings. Thus, we can see some improvement in the disclosure practices of the companies as they are forced to share information with their investors.

What about India?: Traditionally, investing in the Indian market has been broker-driven. True, brokers do act as analysts, but their importance has not been great. However, with the technology boom, many companies have been raising funds in international markets through ADRs, GDRs and other exchange-traded products.

This also means that they have a bigger following as analysts track the price movements in international markets. This means that the companies performance will also be under scrutiny. Of late there has been a rise in the number of companies being tracked by analysts. Corporate India is slowly, but surely, progressing by embracing analysts. Soon the analysts may even influence price formation in the domestic market as well.

Analyst information is likely to be useful by investors looking to invest from the long-term perspective. There may have been successful investors such as Mr Warren Buffett, inarguably one of the most successful investors of all times, but not everybody can claim to have his insights or analytical skills. Given the large retail investor base in India and the nascent status of the technology sectors, the information provided by analysts will definitely have value.