Analyst Call on Baidu Shows Why Most Wall Street Research Calls Are Useless

There are several reasons I typically ignore Wall Street analyst calls. The most compelling is the fact that sell side recommendations over the long term have been shown to underperform the market with above average volatility. Those are lose-lose metrics for investors.

Such poor performance is largely attributable to analysts being backward looking when they make research calls, despite the fact that they are supposed to be analyzing the equity market, which is a forward looking mechanism. Too many times analysts will upgrade stocks after the firms report strong numbers and vice versa, which does nothing to add to investor returns relative to the benchmark index they are trying to beat. Successful investing requires insight into the future, not reaction to the past.

To illustrate this point, consider an upgrade from UBS analyst Wenlin Li on Monday. Li covers Baidu.com (BIDU), the internet search giant in China. Baidu reported second quarter earnings of $1.61 per share, above consensus estimates of $1.44.

Prior to the earnings report Li had a sell rating and $150 price target on Baidu, which was trading over $300 per share. That in itself appears to be a contrarian call, which would be commendable (wrong, but commendable nonetheless). After the strong report was released, despite only a small upside surprise, Li upgraded the stock to neutral and raised the price target to $380 per share, a stunning increase of 153 percent.

How does a single quarter’s earnings beat of 12 percent explain a 153 percent increase in one’s fair value estimate for a stock? It doesn’t, not by a long shot. This is the epitome of a completely useless Wall Street research call.

To see how this analyst messed up so badly, we only need to look at the changes made to their BIDU assumptions. Li now estimates 2009 revenue at $658 million, up from $542 million, while 2010 and 2011 sales are revised upward by 33% and 38%, respectively. Gross profit as a percentage of sales estimates were also revised upward, by 60% this year, next year and 2011, and net profit was revised up by about 40% per year.

Remember, an analyst’s sole job is to follow companies and estimate how much revenue they will bring in and what proportion of that will flow through to the bottom line. Without solid insight into these metrics ahead of time, analyst calls are of little use to investors, which unfortunately is the case more often than not on Wall Street.

Full Disclosure: No position in BIDU at the time of writing, but positions may change at any time

Enjoy this post? Subscribe and never miss another one: RSS | Email | Twitter

4 Thoughts on “Analyst Call on Baidu Shows Why Most Wall Street Research Calls Are Useless

  1. I agree this point in many cases.

    But BAC call on GS before earning release and GS’s call on GE were some call with great impact and these calls made a turning point in price.

    In case of BIDU,I want to know your personal opinion on the possible price target ( just rough estimate ) at the end of nextQ and the end of this year.

    Thanks

    Linn

  2. Chad Brand on August 10, 2009 at 9:37 AM said:

    BIDU really isn’t my cup of tea given that it is trading at ~40 times 2010 earnings estimates (I’m a value guy). It’s hard to argue that the P/E should rise, so long term earnings growth rates (relative to expectations) will dictate the stock price. If they can surpass the currently high expectations, the stock can go higher despite a high valuation. Not out of the question, but not the kind of bet a value investor like me would make. As for a short term prediction on stock price, just flip a coin.

  3. Venticoffee on August 19, 2009 at 9:20 PM said:

    Wenlin Li made a mistake by having a sell target at $150, but his correction of 153% was justifiable. A 12% growth may seem small, but lets not forget that google started out around 60 dollars. Baidu is basically google, but they have a way larger market and lets not forget untapped currently. As China’s GDP continues to boom, while the rest of the world hangs on to what the government does, you will begin to see chinese consumers explode taking full advantage of all the cheap technology and developing their position in the cyber world. It’s China’s turn for a dotcom era. That’s why the 153% correction was a justifiable one.

  4. Ray Ozyjowski on November 2, 2010 at 9:17 AM said:

    Chad Brand, you are now as guilty as your accusation of Mr. Li, so what’s good for the goose is good for the gander. But at least Mr. Li got “himself right” on the call by upgrading the stock, admitting his thinking was wrong and getting on the right side of the trade. Look at the performance since this was originally written, and his rating change. This is not a simple game, of being right or wrong, but is constantly changing. Should he have stayed wrong Chad? It looks like you have egg on your face for staying wrong and not updating your commentary on Mr. Li’s recommendation.

Post Navigation