Open Source Investing: Is Wall Street's Research Game Over?

There's a new disintermediator in town! Just as Electronic Communications Networks (ECNs) have taken the sting out of market making, Tobin Smith, author of a new book called Change Wave Investing and founder ofChangeWave.com, is out to cut the middleman out of Wall Street research departments. Today, the individual is at the bottom of the investment food chain, he says. Moreover, sell-side analysts are "shills of investment bankers," noting that Wall Street's 3,000 analysts had issued 27,000 buy recommendations, versus 35 sell recommendations in January, and the sells had dropped to 18 as of May.

Dubbed open source investing-Smith has developed an approach to picking new economy stocks like Verisign, Checkpoint Software Technologies, Citrix and Vignette-and monster stocks that return 1,000% over 12-24 months-modeled after the open source computing movement created by the inventor of Linux.

Just as Linus Torvalds assembled a global network of programmers who continuously improve the Linux operating system, and share the results with each other, Smith has assembled an alliance of 500 or so "knowledge holders." These are new economy professionals-comprised of sales people, engineers and CFOs-who he has taught to find ChangeQuakes and ChangeWaves.

"A ChangeQuake is a potentially transformational technology or regulation or even strategy," explains Smith. "ChangeWave is where somebody is taking a potentially transformational technology or regulation and packaging it in a Killer Value Proposition," he adds. One recent pick, Tumbleweed Communications, gets paid every time a registered e-mail is sent, and is capitalizing on the SEC's decision to let banks and brokerages deliver statements electronically. Smith's model divides the ChangeWave into layers, and ranks companies that own a strategic piece of the value chain. For instance, Smith's "knowledge co-op" was early to identify BEA Systems in the middleware space. Thanks to an engineer in the alliance that worked at E*Trade, they learned "you can't do a trade today without going through BEA Systems." That's because BEA's Tuxedo takes information from Hitachi mainframes at Charles Schwab and converts that into streaming Java on a Web site.

Smith believes that analysts will continue to laugh off the threat that his approach poses, "until our alliance grows to be 20,000, 30,000 or 40,000 people. "They could never compete with our firepower in terms of the front lines," he says. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio