Analysis off the canvas

Published: June 5, 2001 1:15 a.m. ET

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Notable Amazon bear Jonathan Cohen paints his view



SAN FRANCISCO (CBS.MW) -- If any one event defines the start of the Net bubble, it was the day 30 months ago when analyst Henry Blodget put a $400 price target on

The call emboldened other analysts to experiment recklessly with artistic freedom, leading to a burst of creative number crunching unmatched in modern finance.

In the infamous note, Blodget, then an analyst at CIBC Oppenheimer, said: "Amazon's AMZ, +0.50% valuation is clearly more art than science."

Note that it's the "valuation" he calls art. Yes, analysis is an art form because determining the size of a market and revenue share are subjective. But applying the paintbrush to valuation models, an exercise to be approached objectively, is where analysis broke down.

In spite of the subsequent Net debacle, Blodget's call made some investors a mint. And as Amazon holds its analyst day Tuesday, the conundrum remains: What is the value of sell-side research?

Is it the ability to make good trading calls, and therefore make money for clients? Or is it insight to form sound long-term fundamental analysis?

It's particularly worth pondering as the media examines the deterioration of analyst credibility, largely due to investment-banking conflicts of interest, and the idea that standards bodies are needed to govern sell-side research.

Cohen's short-long view

I sought the perspective of Jonathan Cohen, almost as famous as Blodget, but for the opposite reason.

Cohen, who was a Merrill Lynch Internet analyst at the time, provided the bearish counterpoint to Blodget's bullish call. He believed Amazon was worth less than $50.

It wasn't the first time he'd gone negative. His bearish reputation was fueled after he took the axe to a group of Net stocks back in 1995, marking the downward spiral for many of them including Netscape, now buried inside AOL Time Warner AOL, -1.75%.

Ironically, his 1998 valuation call on Amazon was worthless for those looking for a great trading opportunity. Those who shorted Amazon on his advice might not have been happy, but a long-term individual investor scared off by his warning would now be grateful. It was a solid long-term call.

Amazon went on to trade above Blodget's price target of $400, or a post-split adjusted price of $66.66, for much of the period between January 1999 and April 2000.

Cohen went on to join online banking boutique Wit SoundView. He was replaced at Merrill by Blodget.

Anyone who listened to Cohen and shorted the stock would have lost money. Anyone who would have taken $1 to short Amazon in mid-December 1998 would have been out of business by March '99.

This is hardly excusable. Analysts are supposed to help people make money. Their research is also expected to generate the trades that bring in revenue.

If Merrill investors had heeded his advice, the firm would have missed the voluminous trading activity from investors buying Amazon shares in bulk that year.

So, I asked Cohen, who recently left Wit SoundView: How much would Merrill Lynch have lost if it kept on a bearish analyst?

First off, he wasn't an industry-wide bear, Cohen said.

"At the same time, we had buy recommendations on Yahoo YHOO and InfoSeek (now buried in Disney)," Cohen explained.

OK. Anyone who followed Cohen's advice by investing $1 in Yahoo in mid-December of '98 and his other recommended stocks while shorting Amazon, and then cashing out by the end of '99, might still be in business.

This scenario, of course, was dependent on a trader's timing, which is based on short-term valuation calls rather than long-term fundamentals. Cohen's report, titled: "Amazon, the world's leading Internet commerce company is too expensive," was truly a valuation call. By that measure, it was early and thus wrong.

Given his lousy short-term call, but solid long-term take on Amazon, my next question was whether he saw analysis as being an academic exercise.

"The last thing I thought was that (research analysis) was an ivory-tower job," said Cohen. "Analysts have to respond to the market. And making investment decisions is a practical undertaking."

Indeed, some money managers say they want analysts who can provide short-term analysis -- like knowing whether a company is losing a client or winning one in the current quarter -- and an analyst who can wear a trader's cap as well.

My final question to Cohen was whether analysts have become shills for companies they cover.

He argued they aren't. "This is based on how analysts are incented and motivated," he said, adding that he was not compensated to increase trading volume or banking business when he was at Merrill Lynch.

And at Wit SoundView, the principal metric for compensation was the quality of work, he said. The structure was never formulaic at Wit. But even if analysts were compensated for banking or trading business, in the long run, an analysts' franchise would be undercut by making lousy stock calls, Cohen said.

"The best way to reinforce credibility is to produce great work," he said. "There's also an entire class of young research analysts reading the negative articles and getting feedback from investors. And they are acutely aware of the state of sell-side research and the need for more objectivity."

Cohen will need to see more objectivity. He left Wit April 1 and has reportedly started a hedge fund. He won't confirm whether he is starting a fund, for fear his acknowledgement could be perceived as a marketing pitch. But should he do so, he'll be spending a lot of time with the same sell-side research we all use.

We're already seeing the renaissance in objective artwork. Let's also hope the budding artists remember what part of the analysis belongs off the canvas.

Cohen did.

"Good art is characterized by inspiration," Cohen said. "But it's also characterized by the basics of composition and perspective."

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