Merrill Lynch now grades stocks on a curve

Following the ground-breaking 2003 "global settlement" of tainted research charges, top banks with large retail units tinkered with their stock rating systems. Merrill Lynch became the latest to adopt a new plan that it calls an "an absolute system with a relative twist." This plan will enforce a grading system, as well as a grading curve--the net result of which, as the New York Times noted, will be an increase in the number of stocks with the lowest rating.  

"Buy" recommendations, by definition, will sport a total return of at least 10 percent, and are the most attractive stocks among peers. "Neutral" ratings will be given to stocks that are expected to remain flat or increase, but be less than buys. "Underperform" stocks are expected to have a negative total return, or are the least attractive within the peer group. The transparency is nice.

The really interesting part is that stocks will be graded on a curve. In the universe of covered stocks, buys cannot exceed 70 percent, neutrals may not exceed 30 percent, and underperforms must be at least 20 percent of each coverage cluster. Twenty percent! That's significantly higher than the industry average the last time I checked. It looks as if Merrill Lynch aims to end the ratings-creep that has plagued the sell-side research industry for years, even after the settlement.  

Retail investors should appreciate the changes. All in all, despite the business model woes, research that carries a brand name like Merrill Lynch still carries a lot of weight. These guys can still move markets. I'd like to see some research about the ROI to research units at big firms. - Jim