Merrill Lynch to cap the number of 'buy' ratings

The Wall Street firm said Wednesday its new equity ratings system will limit analysts to issuing "buy" ratings on up to 70 percent of the stocks they evaluate. Merrill said codifying its ratings calls will make them better reflect how stocks historically perform.

The quality of analyst ratings across Wall Street was sharply criticized at the start of the decade after the dotcom bust. Disillusioned and, at times litigious, shareholders accused some analysts of using inflated ratings to pump up stock prices.

Wall Street firms have responded by stepping up reporting of potential analyst conflicts and, in some cases, increasing how many stocks get a thumbs-down rating from analysts.

Under the system to take effect June 2, Merrill analysts won't be able to rate more than 30 percent of the stocks they evaluate with a neutral rating and will be required to label at least 20 percent of the stocks in their stable with an "underperform" rating.

So what should investors hope for from a stock that carries a "buy" rating? Merrill says stocks given the top designation are expected to have a total return of at least 10 percent in the 12-month period that follows. Stocks with a "neutral" rating are seen as likely to tread water or perhaps increase over 12 months. And those flagged with an "underperform" tag are expected to either post a negative total return or show a gain but be the least desirable of their peers.

Merrill, whose client assets total nearly $2 trillion, said the changes will make it easier for investors to sort the winners from the weaker performers in a sector.

"The basis of the new equity rating system is to reinforce our ongoing drive to encourage Merrill Lynch analysts to adopt the perspective and mindset of top-performing investors and portfolio managers," Candace Browning, president of Merrill Lynch Global Research, wrote in a note to clients. "By introducing rating distribution guidelines, we can ensure that our analysts distributions correlate more closely with historical return statistics."

But not all observers think the changes will necessarily make ratings calls clearer for some investors.

"A lot of investors take the terminology at face value," said J. Bryant Evans, portfolio manager and investment adviser at Cozad Asset Management in Champaign, Ill.