A sobering look at ER from motley fool... true/false?
Hey guys, in my quest to further understand the ER field, I came across this article (fix the link) fool.c0m/investing/general/2013/06/03/the-shocking-truth-about-wall-street-stock-recomme.aspx
It is basically claiming that the success rate of ER analysts is based on how good their relationships are with the companies they cover (aka how much insider info they have) and NOT based on past track records. If so, it makes the job look like you need to kiss companies ass's to get insider info that you can relay to hedge funds and other investment funds as a main driver of success. Analysts with good relation to their companies are more in demand even if their track record is NOT great which sounds counter-intuitive to making good stock calls and getting rewarded for it.
It also says that there is tremendous pressure on analysts to not issue a hold/sell recommendation. I can imagine this leading to false ratings as some analysts wont issue negative reports since this is not what people want to hear. Are these things really that true?
Can someone confirm/reject this and provide any other insight?
I think that ER is supposed to make public the ratio of sell/hold/buy recommendations in order to discourage them from issuing only strong buys.
On the other hand, if you read a research paper from an investment bank, you will see that they usually waste an entire page in small font to tell you should take their advice with a grain of salt because they have a clear conflict of interest. They are not your financial advisor. The reason they exist is to spur deal flow for the banks, not to help you make money.
There are thousands of sell side and independent equity research firms and they vary profoundly in strategy, clientele, etc. Some don't talk to management teams and many don't distribute research to retail. Similarly, there are thousands of funds with different investment strategies and policies for working with the sell side. Painting the entire industry with broad strokes is misleading, in my opinion.
Fund A has a holding period of 1 day, Fund B 10 years, Fund C 2 years. All want your research on Apple. They might use sell side research in completely different ways. A might want to hear about extremely near term catalysts. B might want a quarterly update call. Fund C might want an excel model as a starting point. Wouldn't those funds measure sell side analyst pick performance differently? The analyst can only publish one recommendation (FINRA guidelines), so you have a horizon and you base your recommendation on that. If you set a favorable recommendation and target based on expected 2017 results and Q1-15 is a big miss, did you fail the short term fund?
Regarding your question about getting "insider information" (material non-public) from management teams and relaying that to clients as a business model, that is false.
This is true. Sell-side analysts aren't paid based on accuracy of recommendations/performance, although that may help with client votes. Research analysts are paid by banks, which do not make most of their money from equity trading revenue. Deal revenue is important, and that's how analysts get paid at the end of the day. If you want to get paid for making accurate stock calls, you shouldn't be on the sell-side.
if you've ever read david dreman, you already knew that. also, they do publish those figures, and at my firm about 10% of our IB clients are rated underweight/sell, with the remainder pretty evenly split between buy/hold.
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