What do we make of these resuks? The number of samples seems far too large for the outcome to be simply chance. No, the evidence indicates a su risingly high level of error among professionals in choosing stocks and portfolios over six and a half decades.

The failure rate among financial professionals, at times approaching 90%, indicates not only that errors are made, but that under uncertain conditions, there must be systematic and predictable forces working against the unwary investor.

Such evidence is obviously incompatible with the central assumption of the efficient market hypothesis.

Far more important is the practical implication of what we have just seen: a plausible explanation of why fundamental methods often dont work. The theory demands too much from man as a configural reasoner and information processor. Under conditions of information overload, both within and outside of markets, our mental tachometers surge far above the red line. When this happens, we no longer process information reliably. Confidence rises as our input of information increases, but our decisions do not improve. This leads to another rule.

RULE 4

Tread carefully with current investment methods. Our limitations in processing complex information correctly prevent their successful use by most of us.

While it is true that experts do as poorly in other complex circumstances, the market professional unfortunately works in a goldfish bowl. In no other calling I am aware of is the outcome of decisions so easily measurable.

Examining the stock-picking record of money managers and other market professionals, a critical question is how accurate are analysts earnings estimates, the key element underlying stock selections, and the heart of investing as it is practiced today. That question is examined next. The results of some very thorough studies on the accuracy of the top security analysts on Wall Street will su rise you.

Would You Play a 1 in 50 Billion Shot?

1 HE RED wing of my imaginary casino had some pretty awful odds for the players caught up in the frenzied atmosphere. Yet the poor results, to extend the analogy, were not all the fault of the casino operator. On your stroll through, you may have noticed that players kept asking-and paying-for advice from a collection of well-dressed men and women who seemed to know everything about the game.

In this chapter, well examine the advice of this chic group, who happen to be security analysts. Their estimates are the crucial factor the majority of investors look at in deciding what stocks to buy, hold, or sell.

Although they dont agree on many issues. Wall Streeters and financial academics concur that company earnings are the major determinant of stock prices. The heart of modem security analysis centers on predicting stock movements from precise near-term eamings estimates. As a result, major brokerage houses have research budgets in the eight figures, and hire top analysts to provide accurate estimates. The largest bank tmst departments, mutual funds, and other institutional clients demand the "best" because of the tens of millions of dollars in commissions they command.

Institutional Investor magazine several decades ago formalized the process of determining the "best" analysts. Each year the magazine selects an "All-Star" team made up of the "top" analysts in all the important industries-biotech, computers, telecommunications, pharmaceuticals, chemicals--after polling hundreds of institutions. There is a first, second, and third team for each industry. The magazine portrays the team on its cover each year, dressed in football uniforms with the brokerage firms name on each stars jersey. The competition to make the teams is fierce, and many analysts and their sales forces spend a

month or two before the selection begins caUing or visiting major institutional clients and providing that extra something that shows why they are All Stars. Making the "team" is a tremendous boost to the analysts career. Being selected to the first team can garner the analyst a salary of seven figures and can net his or her brokerage house several times that in commissions.

If a brokerage firm can boast a number of All Stars, profitability ratchets up accordingly. Some years back, the managing partners and the director of research of a large brokerage house decided to let one of their analysts go. The office executioner was on his way to inform the analyst, when the research director came running down the corridor, grabbed his arm, and gasping for breath said, "Wait... we cant do it... he just made the second team."

Salary scales, as you may guess, are in the stratosphere. According to Institutional Investor in mid-1995, "the bulk of experienced analysts make between $300,000 and $500,000 a year; standouts receive more than $600,000." At Merrill Lynch alone, more than 30 analysts make $500,000. Then there is the million-dollar-a-year club, which includes several dozen of the Streets outstanding oracles. Income-wise, they are in a class with entertainers and professional athletes.

Brokers launch bidding wars to bring top analysts aboard. In one day in early August 1995, Lehman Brothers, Inc., lured back a healthcare analyst from Salomon Brothers before he could even start work, while Merrill Lynch snatched three analysts from Salomon. Two of the three were top insurance analysts who would each receive an annual package of $1.2 million. At the same time as its Salomon coup, Merrill paid $1.2 million to a health-care analyst and $700,000 to a computer analyst. Lehman hooked a top life insurance analyst from Merrill, while earlier in 1995 Morgan Stanley offered Stephen Girsky, a highly regarded auto analyst, a $1.4-million-a-year package to reel him in from Paine Webber. That firm, in tum, offered over $ 1 million to bring in a health-care analyst from Lehman. Lehman raised its bid even higher, however, and the analyst jumped back. According to The Wall Street Joumal, "part of the heavy analyst tumover is seasonal. Brokerage firms typically like to hire top analysts before September 1-the cutoff for the annual rankings by Institutional Investor magazine for its widely watched All-Star Research Team."2

Some analysts now eam over $2 million-exceeding the pay of a number of CEOs of Fortune 500 companies. Jack Grubman, a highly regarded telecommunications analyst, jumped ship from Paine Webber to Salomon. The price was a two-year contract with annual pay of $2.5 million. The salary was so high that his research colleagues jokingly re-