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Subject:  The New Paradigm Shift Date:  1/11/2001  7:33 PM
Author:  TMFMycroft Number:  26709 of 42074

The New Paradigm Shift that the Investment world is Entering

We are entering a period in the stock market that no one has ever seen before and will cause the Stock Market to change the way it does business on a daily basis. (The following is the result of a conversation that I had on this subject with a very good analyst at the Fool TMF Bobdog). The reason for this change will come as a result of the new policies put forward by the SEC concerning Fair Disclosure. Fair Disclosure for those who don't know, is when a company is not supposed to give preferential guidance to any special group, such as a major brokerage house or large investor concerning what its future earnings will be, unless they give it to the entire investment community at once.

This has not been the way Wall Street has worked in the past. In the old days a Merrill Lynch or Goldman Sachs Analyst would just walk into a companies headquarters, present what he or she thought the estimates would be going forward and the Company would then tell them yes or no as to the accuracy of their numbers. This created a scenario of group think that allowed for the professional investment community to have an unfair advantage. This though also created a certain stability, as when companies missed their estimates they did not miss by much.

The latest report by Yahoo has shocked the investment word as the forecast going forward for 2001 was released to the entire investing community with no guidance before hand. If you read the Wall Street Journal today you will find that the Analyst community got it way wrong. For example W.R. Hambrecht & Co. Analyst Derek Brown expected the company to report 59 cents in 2001, but the company said that it would report in the neighborhood of 33 to 43 cents. That is a large miss that would not have been made in the old days for Mr. Brown would have gotten guidance from the Company before the earnings forecasts were released.

This is probably one of the reasons that you see so much volatility in the markets these days. Since professional analysts are kept out of the inner circle, they cannot be very accurate, thus they have to actually work very hard to find out what is going on. But the best they can do is guess for no one finds out for sure until the entire investing community finds out. The great companies though have combated this fear and have decided to do things like preannounce product sales or even earnings reports ahead of schedule in order to prevent a group think scenario to develop, when other companies in their industry report terrible numbers. Last year Jorma Ollila of Nokia preannounced his company's earnings prior to Ericsson's earnings report in order to protect his investors. He did the same thing this quarter as he reported actual sales of Nokia phones prior to the Motorola earnings report, in order to keep the entire community informed. The stock fell but then rebounded after the community finally had a delayed realization that Nokia had actually increased sales by 64% in the handset division. This was below estimates that might have been outrageous to begin with. John Chambers of Cisco Systems the other day met with the Investing Community and told investors that the year ahead will be more challenging for Cisco's customers. Now this throws all the analysis forecasts out the window and causes nothing but pain for the professional investor.

The result of this new Fair Disclosure policy will be that the Analyst will become more conservative as they cannot get inside information anymore like they used to. Thus if they make wild estimates like they did with Internet companies like Amazon and Yahoo, they will be forced now to take responsibility for those estimates. What the Investment world will see going forward are words like "Quality of Earnings", "Consistency" and "Wise and Experienced Management" being used more often. Qualitative analysis will enter the picture and Analysts will actually have to start doing Scuttlebutt. They will have to knock on doors of suppliers and figure out what is really going on. Everyone is on a level playing field now so the really good analysts will rise to the top and the below average ones will be weeded out.

The small investor is seeing first hand what happens when analysts get it wrong or predict scenarios that are unachievable even in the best of times. Companies with management who have no experience or earnings will be judged harshly. I am still not convinced that Value Investing will make a comeback unless it includes an analysis of the management as well. A company like CMGI is trading for about what it has in Cash in the bank, but it has not proven itself to be of value for it is not earning money. Many people including myself have been burned trying to pick a bottom for such companies. A definition of what Value is must be clarified in this new Paradigm. Many analysts will find themselves pointing to the work of Philip Fisher in the years to come for they will need some kind of strategy to follow in order to find out the details that they used to receive from management before this Fair Disclosure Policy came out. I believe that they will be very satisfied with what they find.

Which companies will outperform in this New Paradigm. The ones who can successfully answer the following questions;

The key words that will be used in this new Paradigm are

Quality of Earnings
Wise and Experienced Management

Words that will be discarded are

5-year growth projections
Future Revenue Streams

Reality is upon us now and Quality of everything from Earnings to the products themselves will be judged. This is where I believe the future will go, but then again this is just my humble opinion.


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