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Sweet Dreams

The road to investment success is fraught with nightmarish realities.

by Bill Steinberg

t’s hard to dismiss the true stories of how individual fortunes were made over the years by the fantastic appreciation of a common stock like Wal-Mart. If you had bought 100 shares of this issue in 1970, with an investment of $1,650, it would have appreciated to approximately $2,700,000 by 1994, according to Fortune Magazine.

We can all dream those sweet dreams about what it would be like to own affordable shares in a corporation that might become the next millennium’s miracle stock. We’re only talking about your possible ticket to complete personal financial independence, and beyond. So it may come as no surprise that daydreaming optimists seek a basic mastery of stock trading in order to position themselves within reach of grabbing that elusive brass ring on the investment merry-go-round.

Even today, during the age of the Internet, a large portion of stock transactions are still processed through national and regional brokerage firms. But, for the most part, the brokerage system tends to favor big-money customers. Smaller accounts can often get lost in the shuffle.

Usually, the process starts when an investor is solicited by a stockbroker who makes specific buy-and-sell recommendations that are backed up by the firm’s research department. These timely research reports comment on the changing financial fortunes of a corporation, attempting to predict movements in the share price of that company’s common stock. Typically, the broker and the firm share a commission that is charged whenever an investor authorizes a buy or sell transaction. Hopefully, by following the firm’s transactional recommendations to buy low and sell high, the investor will make money, too.

When new information about a company’s financial status is revealed to the public, it is the job of the analysts to make the firm’s brokers aware of these developments. But because it is physically impossible for a broker to relay urgent news to all his/her customers simultaneously, there could be a natural tendency for brokers to service their largest accounts first, buying or selling stock at what might be the most advantageous share prices, before trading opportunities vanish.

If you are a small investor, you may not always be receiving prompt notification of breaking developments for the stocks in which you have the most interest.

In addition to underwriting initial public offerings from the home office, some brokerage firms also help companies that are already publicly-traded to raise additional capital, without having the hassles of dealing with the banking industry. These secondary offerings generally represent a profitable enterprise for the firm.

The average investor might not realize that a research analyst may stand to receive a significant finder’s fee when a corporate finance deal is completed with one of the companies he or she follows.

It is possible that at times a potential, undisclosed conflict of interest may exist when an analyst believes, or is aware, that an upcoming multimillion-dollar corporate finance deal underwritten by the firm may depend on instituting or maintaining a “strong buy” recommendation on that company’s stock.

Imagine if you, as an analyst, had tens of thousands of dollars, or even much more, of bonus money on the line, pending the completion of a corporate finance deal. We’re talking about enough money to put you on track to start building your dream home. Or the biggest single deposit that you might ever apply to your retirement savings. How hard would it be to walk away from that kind of money?

An analyst certainly would have to walk a fine line. It would be important not to alienate the executives of the corporation you and your firm are courting by being overly critical of corporate events or downgrading your research recommendation. But, at the same time, you would also need to be able to promise accurate, balanced financial information to the investing public.

As a reasonably skeptical investor, you might be on the lookout for perennial “strong buy” recommendations from your brokerage firm’s analyst on a stock that just never seems to appreciate for its shareholders. Analysts’ explanations for why a stock chronically under-performs can sometimes begin to resemble a literary art form.

In all fairness, the overall job of predicting corporate earnings is an imprecise science at best. Analysts often have to deal with the substantial hurdle of corporate contacts who by law may not divulge inside information or could be overly zealous about internal company developments.

Not all research analysts work for brokerage firms or harbor the secondary goal of securing corporate finance deals, however. Other analysts work with a more singular purpose for mutual fund companies and institutional money managers.

Sweet investment dreams can often give way to brutally harsh, nightmarish realities. Trading stocks may involve more risk and expense than is necessary for many investors to reach their goals of capital appreciation. A few bad picks can have devastating consequences. Bear in mind that for every long-term success like Wal-Mart, the floors of the exchanges are littered with laggards and losers.

(William I. Steinberg, CFP is an advisory associate at the Memphis financial planning firm of Kelman-Lazarov, Inc. and a registered representative with Financial Network Investment Corporation. His e-mail address is )

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