Goldman Gets 38% Right as No. 1 Firm Rating Financial Companies


It’s been a rough three years for banks, securities firms and insurers -- even rougher for the analysts whose job it is to predict how the stocks of these firms will perform, Bloomberg Markets reports in its November issue.

Starting in the second half of 2007, the financial system unraveled. First, the market for securities backed by subprime mortgages collapsed. By the second half of 2008, stock markets around the world were in free fall. Then, starting in March 2009, stocks roared back in the most powerful rally since the 1930s.

“I don’t even remember when things were normal,” says Daniel Harris, a financial services analyst at Goldman Sachs Group Inc. “Every analyst that has been around in financial services during this time has a newfound respect for the depth that stock prices can go to.”

A semblance of normalcy returned to the markets in the summer of 2010, says Frederick Cannon, co-director of research at investment bank Keefe, Bruyette & Woods Inc. “We actually had a stretch this August when most of Wall Street went off to the Hamptons and you could finally take a little bit of a breather for the first time in three years.”

Goldman Sachs and KBW did better than most at figuring out where markets were headed. Goldman is No. 1 and KBW No. 2 in the Bloomberg Markets ranking of the world’s best financial sector research firms. Goldman’s Harris is one of the top three analysts of financial service firms, according to data compiled by Bloomberg.

2,500 Analysts

The ranking is based on stock recommendations made by more than 2,500 analysts worldwide at 77 research firms and investment banks from January 2008 to July 2010. It looks at the analysts’ “buy,” “hold” and “sell” calls on shares of 90 of the largest banks, diversified financial service companies and insurers in the U.S., Europe and Asia with at least 20 analysts covering them.

Even the best of the firms and individual stock pickers failed to accurately predict the fall and rise of most big financial stocks. Goldman Sachs’s analysts won their No. 1 rank by making 30 accurate calls on the 79 financial stocks they follow, or 38 percent, while KBW’s No. 2 post was based on 27 prescient calls on 78 stocks.

“It was a very difficult climate to make stock recommendations in,” says S.P. Kothari, a professor of management and deputy dean at Massachusetts Institute of Technology’s Sloan School of Management in Cambridge. “First, you had to predict the downfall of the financial sector in 2008, which only very few people did. Then, you had to change your outlook to catch the recovery -- all within a relatively short period of time.”

Looking for Ideas

Jason Brady, a managing director at Santa Fe, New Mexico- based Thornburg Investment Management, which oversees about $56 billion, says he doesn’t read analyst reports for picks on individual stocks.

“It’s unusual to see original thinking in these reports, even though that’s what’s most valuable to me,” he says. “The ones who are different aren’t always right, but they’re frequently the most interesting and thoughtful.”

Harris’s best call was the “buy” he put on retail broker TD Ameritrade Holding Corp. on Dec. 9, 2008, according to Bloomberg data. The shares sold at $12.80 at the time and rose 46 percent in the following 12 months. After the Goldman Sachs analyst put a “hold” on the stock in December 2009, it declined 16 percent through the end of July.

Schwab Sell Call

While he called the rise of TD Ameritrade, Harris advised investors to sell Charles Schwab Corp. in September 2009 before going to a “hold” recommendation earlier this year; its stock has since fallen 16 percent.

“We liked Ameritrade better than Charles Schwab because we thought their management was being more aggressive in what they were trying to do to battle a very challenging environment,” Harris says. “They were active managers of their capital. They made the acquisition of Thinkorswim to boost their trading activities.”

TD Ameritrade acquired Thinkorswim Group Inc., a New York options brokerage, in January 2009 for $748.6 million to tap into fast-growing investor interest in the options market.

Volatile markets have been the least of New York-based KBW’s tribulations. In 2001, the investment bank lost 67 employees, including 22 from its research department, in the Sept. 11 terrorist strike that brought down the World Trade Center.

‘A Wild Ride’

“It’s been a crazy time for us for the past nine years,” says John Howard, 56, co-director of research with Cannon. He has been at KBW since 1982 and moved to research from sales in 2001 as part of the effort to rebuild that department. “Combine 9/11 with everything that has happened over the past couple of years in the market, and it’s been a wild ride for the firm,” he says.

Howard sits in KBW’s “living room” -- a lounge on the fourth floor of the firm’s new midtown Manhattan offices -- next to a memorial sculpture made from a steel girder salvaged from the Trade Center. The sculpture complements a painting of an American flag in the lobby with the names of the KBW dead written on the stripes.

KBW is the seventh-largest U.S. investment bank, with a market capitalization of $949.9 million and a total of 562 employees today. It provides advisory services mostly to other financial firms.

Crash Economics

The market crash and subsequent rise made equity analysts’ jobs harder, because the events had little to do with individual companies’ performance, says Anton Schutz, who uses KBW’s research and trading services in his management of $250 million in financial shares at Mendon Capital Advisors Corp. in Rochester, New York.

“Macro developments drove the stocks so that intelligent stock picking was difficult,” Schutz says. “But you still had to make sure you didn’t buy the losers such as Bear Stearns and that you picked the survivors such as JPMorgan. KBW helped solve that puzzle for us.”

Cannon, 54, says his analysts do bottom-up research, focusing on a financial company’s fundamentals more than on the economic climate in which it’s operating.

“We were able to see macro trends during the financial crisis because we were looking so hard at the micro level,” he says. “When we looked across the about 600 banks we cover, it was staring us in the face.”

A Hold on Discover

KBW analyst Sanjay Sakhrani, who’s one of the top two U.S. credit-card analysts, according to Bloomberg data, reacted early to deteriorating economic conditions by putting a “hold” on the stock of card issuer Discover Financial Services in December 2007, as delinquent payments began to rise.

The stock fell 39 percent in the next 18 months. In the 13 months after Sakhrani, 35, switched to a “buy” rating in June 2009, the stock rose 44 percent.

Sakhrani in mid-August 2009 added American Express to his buy list. He thinks American Express will benefit from a rise in consumer credit quality, growth in spending and an increase in fees.

Goldman’s Harris says that, unlike KBW, his team uses the expertise of the firm’s economists to help pick stocks. Goldman was one of the first banks to predict, in 2007, that interest rates would remain low for a long period of time. At the end of 2009, it forecast there would be no rate hike until at least


“I leveraged the knowledge and the forecasts that Goldman had on interest rates and unemployment to help me determine what the best stock selections were,” Harris, 36, says. “Our macro research helped our micro research.”

Burnell Picks Goldman

A timely “buy” rating on Goldman Sachs itself helped earn Wells Fargo & Co. analyst Matt Burnell a spot among the best analysts of diversified banks. His call came in April 2009, a month after the market turned positive. By July 30 of this year, when he still had a “buy” on the stock, it was up 33 percent.

Burnell, 48, says he saw Goldman stock rising because of its strong market position and modest exposure to mortgages and other loans. At the same time he rated Goldman a “buy,” he put a “hold” on investment bank Morgan Stanley because 62 percent of the bank’s common equity consisted of shaky commercial mortgages and other real-estate investments. The stock has been flat since then.

Before moving to Wells Fargo, Burnell worked in fixed income for 12 years at Merrill Lynch & Co., now owned by Bank of America Corp.

‘Balance Sheet Perspective’

“As a fixed-income analyst, you have more of a balance sheet perspective as opposed to an earnings-per-share focus,” he says. “Also, knowing how the debt market works can be very helpful because bond price movements are often a leading indicator of stock price movements.”

When financial stocks began their recovery in mid-2009, many U.S. regional banks outperformed their Wall Street counterparts. Deutsche Bank AG’s Matt O’Connor made a series of calls on U.S. regional banks that places him among the best three analysts in that category. He’s also one of the best three analysts of commercial banks.

Deutsche Bank ranks No. 3 among firms with the largest number of accurate calls.

The 35-year-old O’Connor’s best regional bank call was his June 2009 “buy” recommendation on Minneapolis-based US Bancorp. By the time he put a “hold” on the stock in May, it had climbed 45 percent. After his “hold,” it declined 7 percent through July


Keeping Doors Open

“We had noticed that a lot of banks were pulling back in key business areas, but because US Bancorp was stronger it had the ability to keep the doors open for business,” he says. “The downgrade came after the weaker banks had gotten stronger, and we wanted to take profit.”

As the financial crisis rippled across the globe in late 2008, one hard-hit country was South Korea. The economy and stock market fell so far so fast that President Lee Myung Bak declared a national emergency. Gross domestic product contracted

5.1 percent in the last three months of 2008 alone.

Five months after the national alert, top Asian equity analyst Hunpio Hong of KTB Securities Co. in Seoul went from a “hold” to a “buy” rating on Korean banks, according to Bloomberg data. His best call was his June 2009 “buy” recommendation on Seoul-based Shinhan Financial Co. By the end of July this year, the stock was up 54 percent.

Shinhan is South Korea’s largest financial company by market value.

‘A Difficult Decision’

“It was such a difficult decision at the time,” says Hong, 42, who has a Master of Business Administration from the University of Washington. “The stock performance had partly been beyond my analysis because of the crisis, but in mid-2009 I saw that the downward trend of Korean banks’ net interest margin was coming to an end.”

The net interest margin is the difference between what a bank pays in interest to depositors and what it earns from loans.

While most South Korean banks have come back from the crisis, Europe’s have not. The region’s financial institutions fell more than 50 percent from January 2008 through July, according to the Bloomberg Europe Banks and Financial Services Index. Chintan Joshi of Nomura Holdings Inc. ranks as one of Europe’s premier bank analysts for finding exceptions to the bad news in the Scandinavian market, according to Bloomberg data.

“The world was in a very bearish place at the time,” says Joshi, who came to Nomura when it acquired Lehman Brothers Holdings Inc.’s Asian and European operations. “But the Nordic macroeconomic situation was better, and the banks didn’t have much exposure to U.S. subprime mortgages.”

Nordic Lights

Joshi, 31, works from London for Tokyo-based Nomura, tied at No. 14 in Bloomberg’s firm ranking. His best call was a March 6, 2009, “buy” recommendation on Oslo-based commercial and investment bank DnB Nor ASA. The bank’s stock had soared 272 percent as of July 30.

Earlier, in November 2008, Joshi had given a “buy” recommendation to Oslo-based Nordea Bank AB. Nordea’s stock gained 44 percent before Joshi put a “hold” rating on it in September 2009. It’s been flat since.

MIT’s Kothari says that what often distinguishes successful analysts is their willingness to take a risk.

“It’s essential to have the courage to be a little bit different from the herd mentality that most analysts may exhibit,” he says. “That courage is what makes some of these analysts stand out.”

The analysts themselves say picking stocks in some of the most volatile markets in history has been an education.

“The past few years have probably been the biggest learning experience I could have had as an analyst,” says Goldman Sachs’s Harris. “The environment was so volatile and so uncertain. That shapes you.”