On non-linear payoffs, Blodget, Bove, and the banks

Punk Ziegel analyst Richard Bove made headlines last week by pronouncing that the financial crisis is over and that this is a once-in-a-lifetime buying opportunity in bank stocks.

Is he right? Maybe, but I doubt it. That doesn't mean it was a dumb thing to do. The key is that the payoff is non-linear. If he's wrong, there's little downside. Maybe he loses his job and winds up somewhere else on Wall Street. You don't get on a permanent blacklist for a single bad call on Wall Street, no matter how bad the call. Ask John Meriwether or Brian Hunter.

If he's right, however, the payoff is enormous. He instantly becomes one of Wall Street's top analysts, earning millions of dollars annually. This is the Henry Blodget model. Blodget, an obscure young English major working at a second-tier firm, put an outrageous $400 price target on Amazon stock. When the Internet bubble carried the stock to, and beyond, that target, Blodget's whole career was made. He was hired by Merrill Lynch within months and made enough money in the next 2 years to be set for life.

I don't think the financial crisis is over. But if Bove's call has even a 5% or 10% chance of being right, it's a rational thing for him to do.