We Are Firing the Wrong People


New York, NY – In the tough financial market environment seen over the past year, a number of small hedge funds, agency brokers, and independent research firms have been forced to close their doors.  However, some argue that these firms all provide a valuable service to investors, while Wall Street analysts have consistently misled investors with poor and often biased research.  The following blog, written by Thomas Roulston, the founder and CEO of Cleveland-based Roulston Research, discusses this topic.

Two good friends have closed their Hedge Funds in the last few months. They are smart guys who were making good insightful investment decisions. It just so happens they were not making their decisions based on the U.S. budget discussion or the European debt crisis or inept politicians and regulators in Washington. They didn’t care about all the new offerings in social media remembering the tech bubble that began the last decade. They were looking at the fundamentals of businesses and shorting stocks like Netflix and finding undervalued companies early in their recovery cycle. They were patient and good investors.

Now they are being fired by investors for doing exactly what they said they would do. They are fired by investors that forgot that a hedge fund may not outperform in the early stages or late stages of a headline driven economy. They did not care about a media frenzy directing confidence and sentiment. They are fired for not performing in the short term of a volatile market and investment environment. It’s sad that this happens and if those investors had just waited three months they would be vindicated. It’s sad because instead of investors trusting these independent minds, we temporarily have been instead dominated by media, government and research with ulterior motives. Conflicts of interest now drive our thought process. The independent thinkers are overwhelmed by short sightedness and “from the hip” reactions from regulators in Washington to analysts on Wall Street. We are firing the wrong guys.

Companies are challenged to make forecasts anymore. They don’t know when the next rule is going to change. Talk to anyone with FDA, EPA, NLRB or SEC oversight. To say it is unpredictable is an understatement. Why can’t the government just define insider trading clearly? Why can’t they get the energy industry together to set fracking environmental rules into place to set a clear standard? Why can’t proprietary trading by banks/brokers be recognized as front running clients? Why do these people below get paid by buy side firms for their research after Netflix stock in three months drops from $304 to $75? This company lost nearly 10% of their subscriber base in one quarter and none of these analysts whose job it is to forecast and offer insight were even close with their thoughts and opinion. They work in an antiquated and commoditized model.

Independent and alternative research has transformed the traditional broker model. Today between the internet and other resources the decades old reliance on broker-dealers has been replaced by internal research resources at Buy Side firms.  Over the past ten months the media has implicated expert network firms  for their introductions to insider information.  However, the recent insider trading investigation has had less to do with expert networks than with individual “bad actors” and rampant greed. Independent insights from experts with lifetimes of experience in their industry are an immeasurable benefit. They are the best tutors investors can find due to their experience in the  industry. They are used to being pitching coaches to Cy Young winners. Buy Side analysts need the best insight for due diligence.  They also need to hear all sides even if they believe differently. They need to know conflicts and filter information accordingly to add insight to the future. The Sell Side doesn’t do research anymore, they gather data. Consider for a moment where your next research dollar is going. Read these Yahoo quoted excerpts and ask yourself, who are the knowledge leaders to whom your research dollars should be allocated? This information didn’t change yesterday.   

  • Ingrid Chung, Goldman Sachs: She cut her rating on the stock to Neutral from Buy, setting a new target of $75, down from $200. She gave two reasons for the downgrade. One, she writes that she is “disappointed that management is sticking with the “if [we] build it, [they] will come” stance, assuming that consumers will soon forget about the price increase.” And she adds that she is disappointed that the company chose the U.K. for its next market launch, “given the high level of existing competition and the lack of available content there.” Her 2012 EPS estimate drops to $2.09, from $5.54.
  • Mark Mahaney, Citigroup: His rating drops to Neutral from Buy, with a new target of $95, down from $220. “We upgraded NFLX from Neutral to Buy on 5/2 @ $232 with a $300 price target,” he writes. “Our call has been drastically wrong. The 60% price increase in July and the aborted effort to separate the DVD business were 2 major execution errors. Incremental negatives now: 1) a dramatic ramp-up in International expansion spend for 2012 without sufficient evidence of strong Latin American takeup – Q4 guidance implies a [sequential] decline in International Net Sub Adds; and 2) a significant decline in U.S. Hybrid (Streaming/DVD) Subs post the 9/15 negative pre-release. Consumer backlash is mostly the cause, but increased competition is likely a factor.”
  • Vasily Karasyov, Susquehanna Financial: Rating to Negative from Neutral; target to $60, from $124. “Looks like the nuclear winter scenario is playing out for NFLX,” he writes. “Subscriber base expansion in the U.S. appears to be minimal and losses from international launches are weighing on profitability. We think Q3 results combined with Q4 guidance and comments on 2012 put to rest the bull case on NFLX as we know it.”
  • Doug Anmuth, J.P. Morgan: Rating to Neutral from Overweight, target to $67, from $205. “We believe the long-term potential for streaming-only in the U.S. and international markets remains intact and Netflix’s value proposition to streaming only subscribers is unchanged,” he writes. “However, Netflix expects to double its domestic streaming content spending in 2012 and start-up costs in Latin America and U.K./Ireland are likely to come in much higher than we anticipated. As a result, Netflix does not expect to be profitable for the first few quarters of 2012—this compares to previous Street expectations for $5 – $6 of GAAP EPS.”
  • Tony Wible, Janney Capital: Downgrades to Sell, from Neutral, with target reduced to $51, from $102. “The new baseline of sub metrics is troubling, management credibility has crumbled, international adoption is weak, content costs are mounting, and its is clearer that the DVD business accounts for the vast majority of profits,” he writes in a research note. “Furthermore, there are still a massive number of negative catalysts on the horizon including: issues with Usage Based billing, new DVD windows, EPIX exclusivity, DISH promotions, AMZN initiatives, new competition from Apple, streaming cost accounting, and Starz deals with competitors. Management has failed to rebuild faith in the stock, which is still expensive and mispriced by value standards.”
  • Anthony DiClemente, Barclays Capital: He keeps an Overweight rating, but cuts his target to $125, from $260. “We believe the capitulation in shares is overdone and would point to two encouraging data points: 1) gross subscriber additions were up 20% year-0ver-year in the third quarter despite the subscriber reset, and 2) unique Netflix subscribers are expected to be slightly up in Q4,” he writes. “These two points may not have been readily apparent upon a cursory read of the shareholder letter.”
  • Justin T. Patterson, Morgan Keegan: He keeps his Market Perform rating, but cuts his target to $90, from $140. “Netflix is in the tough spot of regaining consumer trust, which makes us skeptical that December will show ‘strongly positive’ net adds. Coupled with rising costs, we need to see evidence, not a hypothesis, of stabilization before getting constructive.”

About Roulston Research

Roulston Research networks resources for independent due diligence and industry knowledge. For institutional investors proprietary forums allow for the sharing of ideas and the insight of industry thought leaders. Roulston partners with former industry executives and consultants with lifetime experience each screened for industry and company knowledge and conflicts to create an elite industry team. These teams consist of varied backgrounds to coach and share knowledge with the highest ethical and unbiased standard. Proprietary roundtables and podcasts allow for investors assessment of talent and personal introductions. Roulston also conducts Think Tanks among companies and consultants to collaborate best practices in industry forecasting.


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