Why "Buy" recommendations are way more prevalent than "Sell"?
Not sure if this topic was already discussed, but if someone has a link, please comment it and I will read it.
I was reading finance literature and a lot of times I find the argument that way more times ER analysts recommend buying than selling. The ratio I often find is 80-90% for "buy" and only 10-20% for "sell". The 2 main arguments are:
1) You need to create goodwill and show that you like those companies to attract them to your bank's products (M&A, LevFin, etc.).
2) You need to attract new customers that would want to buy those stocks, generating trading fees for your bank (because if a non-client reads your report about selling and he has no stock in that company, then there are no fees).
3) Sometimes you're biased because those companies are your clients. If you give a "sell" recommendation they may take it bad and leave your bank.
Even in satire, most academics say that if you look at the past years, it seems that Wall Street is always bullish even if after 1-2 months the market goes down.
So why this happens? Actually, I'm curious how in practice ER analysts' judgment work when giving the buy/sell recommendation through the lens of this issue.
Thanks.
Believe the easiest way to think about this is that historically markets have always gone up, so if you’re recommending sell it’s like swimming against the flow of the river
Fees. Going against companies can be a death sentence for analysts unless you end up being right and even then…
80-90% buy and 10-20% sell is wrong. Most analysts will probably be more 50% hold and 50% buy. A lot of analysts wont have sell ratings at all. It might even be lower than 5% on average.
There’s a lot to lose on sell ratings and not much to gain. Sure, a lot of it is just relationship management with the management of the companies you cover. Sell ratings are also so rare that you really need a lot of conviction to go against the herd.
because most ER people rely on their relationship ability than their stock picking ability.
This is it, buysiders don't really care about your call (that much) aside from your initial argument. They like to get to talk to management teams via meetings you set up and make their own decisions.
ER is relationship building, also pressure from the bankers if the company is a client. Let's say GS underwrites X company IPO, do you think the client will like it if the research analyst initiates with a sell rating, even if the fundamentals suck?
Isn’t it illegal for bankers to pressure ER?
loooool, welcome to the real world son
Outperform rating on companies / good relationship with the management could bring in banking deals
There are some banks with forced ratings distributions. An analyst can’t have more than X% as a Buy and must have Y% as Sell. If you want to upgrade a sell you have to downgrade a buy. You are correct that historically speaking the ratings distribution is skewed toward buy, but slowly things are changing.
Stocks rise because more people make money that way, no?
1. Relationships - but tbh we have decent relationships with companies that we have a sell on.
2. Pitching shorts is pretty difficult a lot of the time
But anyway your %s are skewed. Any half decent research house keeps track of its proportion of buys and sells and makes sure analysts aren't skewing too hard. I'd say it's more like 40% buys, 40% hold 20% sells.
Cuz (SS) ER isn't ER - it should be called 'Equity Research Management' or 'Equity Management'. You get the idea. II-ranked guys make the rankings by their clout, relationships, and ability to coordinate workflows between company management, analysts, buysiders and investors. It's pretty similar to banking honestly - you're hyping things up, putting companies into nice little gift-wrappers, making everyone happy and hitting the road talking to many clients. That's the whole of the sell-side, whether that be ER or IB
If you want to be a stock-picker and do deep research, you should work at a hedge fund, not sellside equity research.
This is one of the first principles mentioned in “margins of safety” by Seth klarman. Like others mentioned, BB ER is about appeasement and streamlining clients for ECM/M&A. They don’t want to risk pissing off CEOs & CFOs
In a perfect world you would have 33% overweight, 33% neutral, 33% underweight. But in my experience, management can become hostile and reduce access as soon as you slap an Underweight rating on them (not always but happens). Given corporate access is a large part of ER's value prop to the buyside, this is a friction to having underweight ratings. Clients value access to management and your insights more than your actual stock picks in my opinion.
At any reputable shop, banking has no influence over research. We cant even speak to bankers without a compliance person in the meeting.
Oh come on now. Don't be dishonest. Young kids thinking about entering equity research need to know what they're getting into.
Sure bankers may not tell you directly what to do but let's say that there is a high correlation between analysts who are fired and the ones who put on a Sell rating on companies that put nearly every other bank on the next deal cover but not yours. Every equity research analyst understands this. It does not need to be said on a weekly conference call.
And yes, not getting access is another thing that will hurt your trading revenue but the elephant in the room is banking revenue.
Side note: In a perfect world, ratings would not be 33%/33%/33%....they would just be honest.
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