Did it mean you had to cut through lots and lots of companies as the
We had fairly large teams of people working with us after a certain point.
Typically, an analyst might cover 12-15, maybe 20 companies. There were more
companies in my coverage universe. But I also had a number of junior analysts
working in my group, some of whom focused more closely on specific sectors.
There were a lot of senior analysts working on those companies with me... There
was a lot of manpower; there were a lot of eyeballs, looking at these
companies, looking at the documents. ...
When in a company's life does the research process begin?
As soon as they go public, or if you're involved in taking them public. It
would begin as soon as you start calling on them to determine whether they were
a good candidate to go public.
Describe that process. You look out at the universe and start calling
It can happen a lot of different ways. It could be initiated by the company.
They could call you and say, "Look, we're interested in building a relationship
with you and having you take a look at our company; tell us what you think."
It could begin with a banker. They could say, "Look, there's this company that
I've discovered that I think is a really great company and they might be a
candidate to go public." Or it could begin with me. ... In some cases, I saw a
company out there that I thought was really cool and wanted to be associated
with, so I called on them. ...
I've talked to a number of CEOs. They say the analyst is very important.
What do you understand that they're looking for in you?
I think they're looking for somebody who is respected in the field, whose
opinion will matter. If that analyst understands the industry better than
anybody else, in the company's opinion, then they're going to be the most
credible source of information on your company. And that's what you want -- you
want an analyst who people take seriously. ...
Let's hear what you were looking for, or how you were evaluating them.
Sure. What you would look for is size of market opportunity; the company's
ability to capture that market opportunity; and what kind of profit margins
they could squeeze out of what they capture. It's pretty simple.
And then you also want to look for an exceptional management team. These were
companies that were pretty much starting from, if not a standing start, [then]
almost standing. They were very, very young companies. But the Internet gave
these companies a chance to grow much more quickly than any companies we'd ever
seen before. So what you wanted to see is the ability to generate traction and
speed, and then a large pot to be going after. It doesn't matter if they're
moving very quickly and the pot is small.
And really, actually, if you take size of market opportunity, their ability to
capture it, or how much they capture; and profit margin and you put some sort
of discount rate on that back to the present, to do a present value -- what
I've just described is really shorthand for a discounted cash flow, which is
actually probably the best way to value a company in any industry.
The problem is the probability that the companies were going to get to those
points was a soft science when you tried to analyze that. So you really don't
know. So you're really looking closely at the company's every move as an
indication of their likelihood of achieving that ultimate goal.
It's not like if they just stopped their business today, it would be worth x.
These companies, as we've seen from the number of companies that have become
worth zero at any given moment... They're actually worth only the discounted
future value. There's very little present value. So that's what made it very,
And it was tricky also because you were taking them public sooner than
companies had been taken public in the past?
What were the internal discussions about that process?
There was a lot of discussion about that internally, and a lot of, I would say,
careful consideration. A lot of discussion, especially at the investment
committee level and the commitment committee level internally in the bank, with
the most senior executives from various departments would meet and discuss
whether we should get involved in an IPO.
Actually, in retrospect, we can see a lot of the companies didn't work out.
There was a lot of risk. To some extent, what you're doing is serving the
market what the market wants. My job as an analyst is really just to lay out
the case for why the company might succeed and why the company might fail, and
to monitor everything they do, and fall on one either positive or negative at
any given point in time, based on what's happened most recently at the company.
For example, theglobe.com was a company that we took public. Initially I
thought if they did X, Y and Z, this could be a company worth a lot of money.
It actually got way ahead of itself in the beginning. The stock went up much
too much on the first day; made everybody a little bit uncomfortable.
But if the company was going to hit the milestones and be on a path towards
success, I wasn't going to turn negative on the company. But over time, as the
company stopped meeting the interim goals which we had set for them, it became
clear that there was much less hope that they would become a successful
So we downgraded one notch, and ultimately downgraded to a neutral, which was
essentially one of the lower ratings that we had at the firm. And thought,
"This is not a company that we believe in any more." But at the time of the
IPO, we thought they had a lot of potential.
You downgraded it to a neutral, and that's the lowest--
There's actually a lower rating at Bear Stearns. It's infrequently used. I
think it's a sell.
You think it's a sell?
I never used it.
You never used a sell?
That's one thing the public doesn't understand. Neutral sounds like "OK,
maybe I should have it." But, in fact, it meant sell.
Well, my ratings were really for our institutional clients. Bear Stearns was an
institutional bank, and everybody knew what that meant. I don't actually agree
with [your statement]. Because if you look at the price action of a stock that
gets downgraded to a neutral, even at a very retail-oriented firm like Merrill
Lynch, the stock goes down dramatically.
But that could be argued to be the result of institutional and large
investors who are savvy?
That's true. But you have a tough time making a case for the unsophisticated
retail investor duped by those clever institutional guys on Wall Street. ... I
would get in a taxicab, and a taxicab driver would recognize who I was from
being on CNN before, and say, "Oh, I disagree with what you think about Yahoo."
I mean, they had a pretty good familiarity with analysts, and what analysts
did, and what the game was. Our research was widely consumed -- by analysts
generally on Wall Street, [and] was pretty widely consumed by the mass
audience. So I don't really agree with that.
You don't agree with the public's naiveté?
But why not issue sells if, in fact, you think it's not a good buy?
What you're really arguing for is a binary system.
I'm not sure I'm arguing for anything, but I'm asking: Why not have a sell
There are three things you can do with a stock.
You can buy, you can hold, you can sell.
Right. So a neutral is a hold. A neutral means you don't think it's going to go
down much further at that point. It's washed out. You wouldn't recommend
blowing it out at that price. ...
One thing the public doesn't understand is, why do you never use a sell
I wouldn't say -- I mean, I don't think it's true to say that people never used
a sell recommendation.
Well, why did they rarely ever use a sell recommendation?
Because I guess they rarely thought that you should be selling the stock. They
thought that maybe it was a longer-term hold.
Was there a feeling that a sell recommendation would possibly do too much
damage to the company [they were covering]? Was that a factor?
Can you be more specific?
There's been that criticism -- and I'm sure you've heard that before -- that
Wall Street didn't issue sell recommendations because they were beholden to
investors on the one hand, but beholden also to the companies. ...
What you want to do as an analyst in your ratings is, you want to communicate,
to try to gather together as much information as you can about a company;
understand where the company is going, what its prospects are. And then a
rating is really just a condensation of all your thinking. There's really not a
lot of information in a rating. I mean, how many companies have buy ratings on
Wall Street right now? Thousands. But they're not all the same. Analysts don't
think the same things about each one of those companies. There are a thousand
different shades of buy. There are a thousand different shades of soft buy.
The ratings are an attempt to condense what is actually a pretty complex
analysis. And actually, if it were in my opinion, I would actually not use
ratings. I think that ratings actually encourage intellectual laziness, and
laziness on the part of the investor that consumes them. And you're going to
get in trouble if you just pull the trigger or not based on an analyst's
rating; you're not going to make money in the market. ...
But the company wants the buy rating on their stock, doesn't it?
Sure. It's nice to be told that that you're attractive. We all like that.
So does that create a pressure coming from that side?
As an analyst, what you're really trying to do is -- I mean you're going to
succeed as an analyst if you do a good job. Your reputation is really what's
going to make your career. And your reputation is made with the markets --
well, actually it starts internally with your sales force, and that's really
your most important constituency. It extends outward to your important
institutional clients. And then in the last couple of years it's also extended
out into the mainstream, because of the popularity of this kind of content on
TV. So if you do a good job there, you're going to be a big success. If you
worry about -- you know, you're not going to want to just please one company
and give them what they want, as a strategy to have a good career. It also
wouldn't be the most honest way to run your career, right? But, but aside from
that, just looking at it purely from a career standpoint, it would be a stupid
thing to do.
One of the other criticisms that has come up now that everybody is playing
the blame game, the stock market went down, is the issue of disclosure of the
interests of the bank. For instance, when you took a company public, you would
issue buy recommendations, or you could cover the stock; usually, it was a buy
recommendation. But you went on television and didn't necessarily disclose the
relationship that the bank had with the company that you were covering.
I would say toward the end of my work at Bear Stearns, a lot of times the
interviewer on TV, from whatever network was interviewing me, would actually
disclose that we had a banking relationship with [the company].
But why not in the beginning? Why wasn't it done more regularly in the
beginning, and why did it change?
I don't know. It wasn't something that we were required to do. It wasn't
something that we were hiding at all. If asked, I'd be happy to admit that.
Frankly, if I was positive about a company, if I was recommending that you buy
it and thought it was a good company, I'd be proud to also be associated as an
underwriter, because it's a company that I liked. In the same way that if I
liked a company, I would want to do the underwriting business for them, because
I was already recommending purchase of the stock. They fit together nicely.
But I think there are some people in the public who think that, when you go
on television and talk about a stock, you're coming from a pure place -- that
you're an analyst on that stock; that there's no other interest that your
employer has in that company; and that, therefore, disclosure is important.
Why do they think that? I work for -- it says, Scott Ehrens, Bear Stearns.
But they figure that Bear Stearns is offering an analyst up there to give
research to investors.
That's right, and that's what we are doing.
And you are doing that. But you're also, in the case of Digital [River], for
instance, an underwriter.
Yes. If we like a company -- I mean, this is what I'm doing. I'm recommending
to investors what they should do, whether they should buy or sell a stock. And
I'm also recommending to my colleagues in the investment banking department
what deals we should be associated with.
I want to be associated with good deals. I want to be associated with good
companies. So it has to be that I'm saying the same thing in both places. It
would be intellectually dishonest if I said I didn't really like the company to
investors, and I was saying, "Go ahead and do the deal." Or vice versa -- [if]
I was saying to the bankers, "I don't really like the company," but to
investors I was saying, "You should buy this stock." I have to be saying the
same thing in both places. It's one opinion.
Do you feel that you should be mandated to reveal your bank's interest in a
company beyond just giving a recommendation?
What I would say, in retrospect, is that's not a bad idea. It doesn't hurt
anything. And more information is always better. When we wrote written reports,
it was always disclosed in writing on the reports. The medium of television as
a way to disseminate your information about your research information was
relatively new. Analysts didn't get the kind of media time in the past that
they did during the Internet phenomenon. ...
[Can you tell me about] conflicts of interest in the banking and analyst
Internally, there can sometimes be conflict between the banking department and
the sales and trading department. They make money in two different ways. The
banking group makes money through doing a deal. Let me preface by saying, long
term, the banker's interest and the salespeople and the traders' interest are
actually aligned, because bankers over the long haul do better if they do good
deals. And salespeople only do well if deals are good.
But upon doing the deal, the banker gets paid, whether it ends up being a good
deal or a bad deal. Bankers' job is to be aggressive in trying to get deals
done. Salespeople would rather just make sure that their clients make money,
that the investors make money.
The analyst is sometimes put in between the two groups. And the analyst is the
one who blesses the deal, and decides if it's a good deal or not. Sometimes
it's a tough position to be in, to say no to a banker. However, it's a very,
very good idea for an analyst's career to get in the practice of saying no to
bankers. Analysts really work for the sales force. ...
As an analyst you don't have one opinion and then it's written in stone. We're
analyzing dynamic things, so therefore, our opinion is dynamic. It's
ever-changing. We keep writing more reports, because we're telling you, "This
is what's happened, and now this is what we think." ...
How is it possible to justify the kind of recommendations you were making
when these first-day pops were so incredibly high that it would require these
companies to grow at really amazing rates?
Those first-day pops were really tough. Those were something we'd never seen
before, or I'd never seen before in any other sector. I guess maybe biotech,
and maybe cable in the early days had certain things like that.
But certainly not in this volume.
Yes, not in this volume. And that was really tough. Again, it goes back to what
I just said, which is why you would change your opinion. And you would change
your opinion on a company based on its performance, and based on its
environment -- based on fundamentals, not based on stock-price actions.
So if the company was continuing to do exactly what it said it was going to do,
and you thought that the news flow out of the company was going to continue to
be positive, it really didn't make sense to downgrade the stock just because it
had appreciated a lot on the first day.
Instead it would make more sense to say, "I'm very uncomfortable with the
volatility of the stock. I could see it continuing to be volatile over coming
days. But overall, I think this is a great company. It's going to continue to
do well. It's going to actually have improving results over time," and I'd want
it in my portfolio; I'd want to be an owner of it. ...
I understand what you're saying about the company being a good company. But
up to the point where you say you want to own it, because you don't want to own
a stock of a good company that's overvalued.
You don't want to step in and be a buyer at that level.
But that was the only opportunity for the retail investor, given those
first-day pops, those IPO shares not being available to the public. They could
only step in at these incredibly inflated prices.
Or you could buy it on dips. I think what we're getting hung up on, again, is
the ratings. You don't want to jerk your ratings around. You don't want to try
to have your ratings reflect your trading outlook, your daily trading outlook.
That would be very, very confusing to everybody.
... These stocks popped on the first day, but then they usually settled
in after that. They would go up. They were very volatile on a day-by-day basis.
So if you had a target, let's say you thought a fair value was $50 a share. And
on the first day it traded to $60. And so then you would downgrade and say I'm
a seller, because I think it's going to $50. And then the next day it trades
down to $47. Well, now I'm a buyer. And then it trades up to $55.
Analysts are not trained to be good traders. We're paid to understand the
long-term outlook of the company, and understand what's going on now, but
really to understand the long-term picture, and make a recommendation based on
the long-term prospects. ...
The whole purpose of CNBC and CNN[FN] was to deliver messages -- not the
whole purpose, but a large part of their purpose -- was to deliver messages to
the general public. The slogan is, "Profit from it at CNBC."
Right, and the way you make money in stocks is by taking a long-term approach.
I'll say, what I think was wrong with the individual investor's approach during
that era: They tried to trade. They were not really focused on what the
long-term outlook was for the company; they were more interested in short-term
pops in the stock. And the people who thought that way ended up getting hurt --
institutional investors, individual investors alike, everyone.
Well, some of the institutional investors did pretty well.
Some got really hurt, though. Some got really hurt. ...
... People are angry at the banks because they feel they conned the public.
I'm not an investment banker, so I don't represent their side of things. But I
would say that there was a huge sucking sound coming from the individual
markets, saying, "Give me more Internet IPOs." There was really a lot of
pressure on bankers to provide more product. The markets wanted it. I don't
think they were shoving things down people's throats. I don't think that that
would be a fair way to look at it, in fairness to bankers.
But this is where the criticism comes in. You were giving sell
recommendations; you were giving only buy, down to neutral.
But when you're doing an underwriting, of course you have a buy. This is back
to what I said before -- how could you underwrite a stock and have a sell
recommendation on it?
But you're saying that the public was eager, had a huge appetite for more
IPOs, but it was the banks that were feeding. You're saying it's not the banks'
responsibility, it was the public's responsibility. But the banks were the ones
that were offering all these up, and giving them these buy recommendations.
Everybody has responsibility in the situation, absolutely. I'm just saying that
the bank's responsibility was to do due diligence, and offer up good product,
i.e. IPO shares, with as much information and insight as they could provide
about those companies and what their prospects were. That was my job.
But a lot of people say that if you really did your job, and were more
square with your investors that you were serving, and gave buy and sell
recommendations, that you would have been out of a job.
I don't agree with that. I think that we were square. ...
Well, then I come back one more time: Why not give sell recommendations on
stocks, on companies that you think are overvalued?
I'd say, why look at ratings? Why the obsession with thinking that a rating
represents the entirety of your point of view? Just like with buys, there are a
thousand different shades of buy. There are a thousand different shades of
neutral. There are a thousand different shades of sell. Because every company
is different. You have to read the whole report.
My personal standpoint is, get rid of ratings. That would be my comment to
Arthur Levitt and to everybody on Wall Street. I think it would make
everybody's job a lot easier. I think it would afford more intellectual
clarity. And I also think that it would make for more successful investing.
But you'd still have to go out there and say, "I like this stock," or "I
don't like this stock."
Well, everybody always did that in their report. A lot of times I said --
You didn't very often.
Oh, no, that's not true at all. I said I didn't like stocks all the time; all
Do you remember?
Oh, yeah, I said it about Amazon. I was one of the first people to turn
negative on Amazon.
Did you ever say about companies that you were -- that Bear Stearns was
I turned very negative on -- I turned very negative on TheGlobe.com. A lot of
companies; a lot of companies.
But didn't want to issue sell recommendations on them? Or weren't allowed
I issued the lowest rating that we gave. But the rating -- I didn't care about
the rating very much. The rating was not the best way to communicate an
opinion. Again, I would say get rid of ratings.
But you couldn't issue a sell. Bear Stearns just wouldn't allow you
Sure they would. People issued sells. I mean have you looked at --
You said the neutral was the lowest that you gave.
That I gave. That was the lowest that I gave.
So why didn't you issue a sell?
I didn't put too much thought into it. I didn't put a lot of oomph behind
ratings. Ratings didn't matter to me that much. It was much more important to
read my report, or to listen to what I had to say. I mean again, it goes back
to what I'm saying about ratings generally.
It used to be that taking companies public was something that was done after
four quarters of profitability. During the Internet bubble, these companies
were taken public well before they had profitability.
Well, you have to actually look in the larger context of technology companies.
Because your premise that companies go public after four quarters of
profitability isn't true when you look in the technology space, even going back
20 years. So it's a little different. It's because the technology companies
have -- and biotech is another example -- these are companies with very, very
heavy startup costs, and then their profit margins expand dramatically once
they achieve some sort of scale.
Do you think analysts did a good enough job of explaining to the public that
they were getting into a much more risky game here?
I can only speak for myself. But we would always write at the beginning of our
reports that these are investments only suited to investors who can withstand a
great deal of volatility, and we always said they were very high-risk
Some people explain that what happened during this period of time was a
great transference of risk from venture capitalists to the general public.
Sure. I would agree with that. It was public market venture capital; I would
say that all the time.
Was it appropriate for banks to participate in that kind of massive
It's an interesting question. Because I could make the statement, and I think
you'd have to agree with me, that the public wanted that. It wasn't being
pushed on them. They wanted to participate in this phenomenon.
But then it raises responsibility issues, regarding the banks. Should they not
have allowed that? I don't know. It's actually a philosophical issue.
Isn't a question of leadership and responsibility on the bank's part?
... The question is, as an adult who's buying a stock, do you want to be told
that this is too risky for you, you can't take this on? Or do you want to make
up your own mind? The information was there for individual investors that these
were very risky investments. And they understood the volatility, because they
were participating in it on the upside, and everybody knows that volatility can
work in both directions.
So then it really becomes an ethical issue, and a very philosophical issue. And
the same issue relates to tobacco or alcohol; it's very similar. Who actually
gets to decide what an individual's behavior can be, if we think it's too
Well, tobacco is a good analogy, because tobacco companies were saying
[that] smoking doesn't cause cancer. And I think that people feel that the
investment banks were telling us that an investment will not cause losses.
But we didn't. There was a surgeon general warning label on every investment
report I put out, you know?
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