What in the world is "Downside Potential?"

Today I'm going to revisit a topic that was posted on this site back on February 27, 2007. In retrospect it would seem that my commentary about Countrywide Financial (CFC) was all too obvious. However, I believe that my commentary then was based on a concept that should always apply whenever reading financial media, "don't trust, then verify."

At the time, CFC was trading around $37.58 a share and according to Standard and Poor's was projected to decline to a level of $36 a share before going higher. As analyst Stuart Plesser put it, "Countrywide's shares have fallen over 10% year-to-date, in our view leaving only modest downside potential." (emphasis mine) For the most part Mr. Plesser was correct. The stock fell as low as $32.73 on April 2, 2007 and then went near it's high at $41.31 on May 17, 2007. However, nearly one year from the old high price the stock has fallen by an astounding 87.8%. The stock sells for $5.12 today.

Could you imagine if, based on Plesser's "upgrade" of CFC on February 27, 2007, someone bought the stock shortly thereafter with the belief that there was "only modest downside potential." Fortunately, most individual or small investors don't invest their money based on the recommendations of a stock analyst at a big ratings agency. Unfortunately, mutual funds, hedge funds, and pension funds do make stock purchases based on rating agency recommendations. To further compound matters, the money that is invested is seldom their (fund companies) own and therefore can easily be put to work.

Other people's money (OPM) also explains the reason why there is so much trading volume on the stock exchanges. Professional money manages can buy and sell with little regard for the consequences. If things go wrong then the managers can say,"I got my information from sources that everyone can agree are considered reliable."

Mr. Plesser is not likely to be held accountable for influencing so many institutions, charged with the responsibly of managing the public's money, to buy a stock so out of whack with reality. You can bet your bottom dollar that recommendations like Plesser's provided the impetus for money to flow from the strong big investors (i.e. insiders) to the smaller weak investors (i.e. mutual fund investors) during the period from February 27 to May 17, 2007. Touc.

Lesson #1: Don't trust, then verify

Lesson #2: The stock market's volumn grows because big money is moving it.

Lesson #3: Never consider buying a stock or a mutual fund at or near a 1-year high.

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What kind of game is this?

Today, Standard and Poor upgraded Countrywide Financial (CFC) from Strong sell to Sell. What kind of game are these analysts trying to play with us? Does it make sense that something which is so unattractive be worth deeming it less dead that previously noted.

This kind of manipulation by analysts raises my suspicions. Are the analysts fearful that, by painting a negative, but accurate picture, it is going to become a self-fulfilling prophsey? Does Standard and Poor have a vested interested in CFC? The justification given by Standard and Poor analyst Stuart Plesser for raising Countrywide from the dead to near dead is that it has been hammered so much that it couldn't possibly go any lower. Come on!!!!

This leads to unjustified optimism without the necessary proof that things have turned around. We need evidence not an analyst's assurance that it can't possibly get worse. This seems all the more outrages when you consider that some 21 companies in the subprime lending industry have filed bankruptcy at or near a perceived top in the real estate financing market (as opposed to the valuation of real estate itself.)

Continue to wait for the proof before considering this company as worth investing in. Countrywide is still a STRONG SELL.

Standard and Poor rating

Countrywide Financial (CFC)

Ups from 1 STAR (strong sell) to 2 STARS (sell)

Analyst: Stuart Plesser

Countrywide's shares have fallen over 10% year-to-date, in our view leaving only modest downside potential. We are concerned about Countrywide's exposure to the subprime market and the possibility of loans being put back to Countrywide due to higher default rates. We also believe that Countrywide's gain-on-sale margin will fall due to a widening of credit spreads in the securitization market. Finally, we remain cautious about Countrywide's option ARM loans, which comprise over 40% of loans held. We are lowering our target price by $2 to $36, 8.2 times our 2007 EPS estimate of $4.37, a discount to Countrywide's historical average.

http://www.businessweek.com/investor/content/feb2007/pi20070227_897788.htm?campaign_id=yhoo

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