What better way to dump a holding than to upgrade the stock and sell out into the strength? It stinks and it happens every day. So as you can see, upgrades and downgrades can have a lot of different meanings and they carry a lot of unknowns with them. 

Major investment firms like Merril Lynch, Goldman Sachs, etc.. each have their own "ratings guide" usually going from a low of "sell" through hold, then accumulate, long term accumulate, trading buy, near term buy, long term buy, buy, and strong buy. But there are others who use terms like "top pick" or "outperform". So each outfit is different but with the same basic meaning. A near term buy from one is someone elses buy. A top pick at one is someone elses "strong buy". The terminology isn't nearly as important as the "size" of the move.

For instance a move from a "hold" to a strong buy means some analyst just realized "Hey! this company that we had very little interest in could be dynamite!" and now wants to tell the world about his discovery. Another thing that you will find is that around earnings season you see tons of upgrades issued especially to companies reporting good earnings and growth. We find some of that a bit humorous as these are the guys who make a million dollars a year tracking companies and then they get "surprised" when one beats their earnings. (isn't that why they analyze them in the first place?)

Now the other side of the coin is the "sinister" part and the reason that we don't get along well with most analysts. They have the power to move stocks when and to what level they want. This is trouble folks. Let's look at some basics here. Investment houses make money basically in two ways. They actually do investments themselves and the other mainstay to their income is commission charges to buy and sell the respective stocks they are upgrading or downgrading.

This is where sometimes a change in a stocks ratings becomes a game of "why?". For instance you can trade online with a number of internet brokerages and pay about 8-25 dollars for doing it. Most of the older established investment houses still charge their clients 200-400 dollars for a trade. So you can imagine how much money they make when they "council" their customers to sell XYZ because of this or that, or buy ABC because of this or that. It amounts to millions of dollars of income for them.

Another dark side of the upgrade downgrade game is that if a major house wants to buy into XYZ but doesn't like the price, it is very simple to downgrade it for some nonesense...watch it fall like a rock...then buy into it a week later at a much reduced price. This happens a lot and although no one will admit to it, it happens more than you would expect. Another nasty game is when a house has a lot of stock they want to get out of they will reverse the game. It works like this.. when you or I buy our 1K shares of XYZ the transaction is quick and easy.

There is always a buyer. But if you are a fund and you want to dump a block of 50K shares it sometimes takes an upward move in the stock to create the "liquidity" necessary to unload that much. What better way to dump a holding than to upgrade the stock and sell out into the strength? It stinks and it happens every day. So as you can see, upgrades and downgrades can have a lot of different meanings and they carry a lot of unknowns with them. Unfortunately we don't know exactly the motives behind every move, so you have to exercise caution when playing with upgrades. Usually it is best to see how the street reacts before jumping in. For instance, on the day of an upgrade the stock usually soars. But rarely does it last and it pulls back after the initial run.

The test of whether the company is one that you should buy into is to watch it for a while and see if a few days later it indeed starts to move up again. If it does, then others have decided that the stock is worthy of the upgrade and are buying it up. If it doesn't, you have to do some research to find if you think its still a good company or if the upgrade was "suspect". This game is as old as the market itself and takes some time to figure out. So we hope that you understand why although we put the upgrades in the letter, we don't automatically recommend buying any of them. It is wiser to let Street tell us if the upgrade was sound!

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