09/16/2008 09:21 pm ET Updated May 25, 2011

The Bridge To Nowhere: Analysts Views On Lehman, Freddie And Fannie

According to a report in the Wall Street Journal, analysts had a pretty dismal record in predicting the downfall of Lehman Brothers.

Wachovia had an "outperform" rating starting on March 14, 2007.

Credit Suisse had an "outperform" rating starting on October 8, 2007.

Merrill Lynch changed its rating to a "sell" on June 1, 2008, but on June 4, 2008 it upgraded the stock. I assume a light bulb went on.

Citigroup had a "buy" rating on Lehman and watched the stock fall by 84%.

Not to be outdone, Deutsche Bank kept its "buy" rating until the stock dropped by 90%.

How about Freddie Mac and Fannie Mae? Surely the analyst gurus gave better guidance to investors in those very public stocks.

Not so.

According to an article in Smart Money nearly half of the analysts covering these stocks had a "buy" rating for them on the date the Treasury announced it would bail them out.

What about small cap stocks? Much is made of the ability of analysts and active managers to outperform the index in this market. We are told that small caps are less efficient than large and mid-cap stocks.

This myth was recently debunked in a study entitled Evaluating Small-Cap Active which was published in the Fall, 2008 issue of The Journal of Investing.

The authors found the chances of an active manager beating the index in these stocks is about the same as a coin toss before costs. When costs are considered, the relative performance of the median active small-cap manager is negative.

The conclusion of the study is unambiguous: "We conclude that indexing is a powerful strategy among small-cap stocks, as it is in any market."

Do you have an account with a brokerage firm? Does your broker discuss with you the importance of analysts reports and the "target price" the analyst has placed on a particular stock?

If so, you are on the bridge to nowhere. Fortunately, there is still time to change your mind and "reverse course."

Just ask Governor Palin!

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