A strange coincidence, or not?
Published 01/09/2013 | 05:00
WHICH embittered cynic insisted that stockbrokers never issue "Sell" circulars?
Probably some brass- necked journalist. Last week, Davy, the doyen of Ireland's brokers, confounded convention. It issued a "Sell" note about Paddy Power bookmakers.
Some poor innocents – somewhere – still take heed of Davy's views on the market. Paddy Power shares tumbled in reaction to the broker's thumbs down.
Davy seems to have its knife plunged into Ireland's top bookies. It is the second time this year it has knocked the Paddy Power shares, rating them in the lowest category – "underperform". Maybe stockbrokers, as glorified gamblers themselves, are a bit sniffy about bookies. The difference between the two is that while bookies punt with their own money, stockbrokers bet with other people's. Brokers rank far higher in the parasite stakes than bookies. I should know. Many years ago, I was that parasite.
Davy gave cogent reasons for its pessimism about the prospects for Paddy Power. It pointed out the "competitive and tax-related headwinds facing the group". Ironically, one of the strongest headwinds blowing against the enhanced reputation of Paddy Power appears to be Davy itself.
No doubt there are good reasons why shareholders should sell Paddy Power stock. Yet I could not help wondering whether Davy's plucky decision to urge investors to dump the shares was exclusively the fruit of weeks of meticulous analysis. Is it merely a coincidence that Paddy Power is one of the minority of listed Irish companies from which Davy does not receive other material income? Would the blue- blooded brokers stick the stake into the heart of one of its publicly quoted corporate clients?
It just so happens that Paddy Power's corporate broker is Davy's arch rival – Goodbody. It just so happens that Davy receives no material income from the bookies. Such freedom from corporate pressures makes it easier for a broker to suggest to clients that they dump the shares. No corporate boss will pick up the telephone and bawl them out. Chief executives of public companies are famously prickly about brokers urging their clients to sell their shares.
Prompted by Davy's bearish views on Paddy Power, I decided to take a look at Davy's current ratings of public companies. (Under current rules, they are compelled to disclose certain information in case of a conflict.) Specifically, I wanted to know how many of the public companies to whom it gives "material investment banking services" (meaning from whom it receives big lumps of income) have seen their shares suffering the Paddy Power "underperform" treatment?
Go on, guess. How many?
Davy are corporate brokers to approximately 70 per cent of Irish listed companies. In the past 12 months, it issued 12 "underperform" recommendations. On the law of averages, approximately eight of those fingered as laggards by Davy would be expected to come from the Davy corporate clients stable. Very strangely, of the 12 given the dreaded "underperform" ranking, not a single one is a material corporate client of Davy. All 12 allot their corporate business elsewhere. On the bullish side, 66 per cent of Davy's coveted "outperform" ratings give Davy work on the corporate side. The bulk of the rest get a "neutral" rating.
A pattern emerged. There is a big overlap between companies given "underperform" ratings by Davy's broking analysts and companies that do not instruct Davy as their broker. On the other hand, all the usual suspects like Davy corporate clients CRH, Bank of Ireland, Kerry Group, Ryanair and Smurfit Kappa win the Davy top "overperform" share rating. Quite a coincidence.
Institutional investors are sceptical by nature, but starry-eyed small clients of Davy follow their adviser's investment advice. Hopefully they are not the same clients who listened to it during the banking collapse. At that time, Davy, corporate brokers to Anglo Irish Bank and Bank of Ireland, was loyal to the last. Defying gravity as late as 2008 when shares in Bank of Ireland had dropped to €9.59, Davy rallied to the corporate cause. It shamelessly puffed shares in Bank of Ireland, claiming that "a low risk balance sheet and cheap valuation provide a safe place to hide ... This is a low risk bank". Even as the shares tanked to 89 cent in 2009, Davy suicidally set a price target of €1.50. Today they stand at 22 cent. Davy is still brokers to Bank of Ireland and is still rating them "outperform". Ouch.
It was equally loyal to Anglo for whom it acted as corporate broker. In 2007, it targeted a share price of €18.50 for the rogue bank. After the price fell to 85 cent, in late 2008, it revised its price target to €3.00. The top brass at Anglo must have been pleased. The shareholders were hammered. Today Anglo shares are worthless.
Davy was not alone in its unswerving loyalty to its corporate banking clients. Neither did Goodbody stockbrokers, doubling up as corporate broker to AIB, believe the market's message about the bank that was its one-time owner. Against a tidal wave of market selling, Goodbody issued "Buy" circulars galore on AIB in August 2006 at €19.94 and in November at €21.81. It was still issuing "Buy" notes in 2008, but downgraded the shares to "Add" in 2009 when they had dropped to 52 cent. Today AIB shares stand at 7 cent.
This weekend, Goodbody is the quintessential superbull. The traditional broker aversion to "Sell" recommendations seems to have reasserted itself. Goodbody covers 46 stocks. At the start of last week, it had a "Buy" tag on 35 stocks, a "Hold" tag on 10 and an unbelievable single "Sell" recommendation.
Frankly, it is ridiculous to anticipate that only one stock of the entire Goodbody galaxy will lose value in the coming months. Last year Goodbody registered the spectacular score of just two "Sell" recommendations, namely CRH and Bank of Ireland. It is hardly a coincidence that both of the companies use Davy, not Goodbody, as their corporate broker. Goodbody never attacked AIB in the good old days. Nor is it doing so today. In response, Goodbody says that it entered another stock, Kenmare, on to the "Sell" list on Thursday.
It is no surprise that Paddy Power is rated a "Buy" by Goodbody. The house broker takes a far more benign view of the bookies' prospects than the gloomier outlook forecast by the brokers who have no commercial relationship with the company.
Stockbrokers have escaped from the Celtic Tiger crash almost unnoticed. The regulator is still allowing them to charge outrageous commissions plus management fees. They are hopelessly compromised by other corporate relationships when they offer investment advice. Sometimes they are even given discretionary powers to invest by naive clients. They earn money by turning their clients' portfolio over, not on performance or expertise. They are still addicted to "Buy" recommendations because it is one of the easiest ways to generate business.
Stockbrokers should be forbidden from making any recommendations about shares in public companies if they earn corporate revenue from them. Based on their performance, they should never be given discretion to invest clients' money. Commissions should be slashed or outlawed. They should be paid on performance, not turnover.
Davy, the broker with a finger in nearly every pie, had few available soft targets for a "Sell" circular. Why did it pick on a humble, but highly successful, bookie?