Why are equity research people so bad at equity research?
I'm an analyst at a HF this summer and with that I've begun to read a lot of tipranks and see what equity research analysts have to say. Maybe it's something to do with tipranks data accuracy but holy moly some of these people are so bad at their job. It blows my mind how many analysts have like average return of like 4% and some even have negative returns on their investment advice. Am I misunderstanding what these returns represent or is it really the case that the average equity researcher cant beat the S&P?
I don’t think you understand the actual job they do
This. Equity Research on the sell-side doesn't generate revenue. However, ER on the buy-side, like ur seat this summer in a HF, depends on above market returns.
I mean, the largest hedge funds don’t really rely on above market returns either
And ER indeed generates revenue.
Wait till he finds out the average buysider doesn't even come close to beating the SPX either.
I hear this so often, and it's just such a bad take. The only reason HFs underperform the S&P is because ever since 2008, everyone has moved metrics over to alpha from beta. They don't want to outperform the market, they want to outperform their benchmark. And most of the time, they do. Hedge funds have done very well during bear markets because of this. Because they're willing to lose a small amount of return for premiums so they can guarantee their downside.
Have you read some of the reports ER analysts write? I read one on Tesla recently. It went like something like this:
"Tesla is seeing a massive strain on earnings due to the EV tax credit pullback. The company is falling behind in growth markets of China and Europe due to competition from BYD and Xiaomi. The company is failing to deliver solid earnings due to a lack of new model releases, a lack of fast charging breakthroughs, and sluggish consumer demand for EVs in the United States. Elon Musk has continued to overpromise and underdeliver. On Autonomous Vehicles, Tesla remains far behind Waymo in terms of their capabilites. Robotics is not projected to make a real impact on the company valuation. The valuation of the firm is incredibly high considering the lackluster growth figures and harsh competition in every area Tesla is competent in. Cyber Truck sales continue to disappoint."
And after all that, what was their recommendation? Buy. Because ER analysts on the sell side are ultimately still, by and large, vehicles to the sales and trading desk. ER analysts are stupid. They know that their consensuses are likely wrong, but that's not the point. The point is that if they recommend selling, or even worse holding, then people don't use the trading desk. So, you want to spark extreme optimism or extreme pessimism.
^ Guy who doesn't understand anything.
I am a sell sider and a covering analyst, what my recommendations do for my trading desk has literally never once crossed my mind. It doesn't matter to me.
Regardless, do you realise trading desks also generate money if clients want to short stocks? And holds can motivate profit taking which, again, generates money for the trading desks...
I'm not saying that ER analysts are making unbiased rating decisions either but to say they are doing so for the sake of being a buy for trading revenue is funny.
If you want to understand sell side analysts, you need only follow the incentives - show me the incentives I'll show you the outcome. I think the comment below this from tcbflash paints a decent picture but to further elaborate ER analysts are often compensated on their client interaction time (directly or indirectly via broker voting). How do they get interaction time? By either 1) being a good source of company information/mgmt access, 2) having out of consensus stock calls, and/or 3) having a reputation for being right a lot.
3) is pretty hard but most stocks go up over time so a buy is the default rating (even if they don't necessarily outperform). 2) is easy, just be controversial and outlandish so far as you are allowed. Adam Jonas (who I'm assuming you're quoting) does this. 1) is hard to do when you're a sell on a stock. Doesn't mean you shouldn't be a sell but that pressure definitely exist. The burden of proof to be a sell on a stock is much higher, in practice, than being a buy. No management team is ever going to call you to shout at you about being a buy.
Maybe I'm operating on a more outdated view of ER. I worked in S&T more specifically before MiFID, and all the ER people I worked with back then said there was pressure from the top to push out really positive or really negative research to drive trader flows. This seems to be outdated.
With apologies, I think you're missing the point some.
In real world terms equity research serves three purposes, roughly in order of importance: to build relationships with managements who might use the advisory services of the publishing institution in a future transaction (translation: court potential sources of investment banking revenue); to provide investment/trading clients with information and opportunities to learn about and meet companies (translation: court sources of sales & trading revenue); and to provide fodder / support for RIAs and strategists making investment recommendations or decisions to clients (translation: support sources of wealth management revenue).
Please note that generating investment returns does not feature on this list. It is not the measure of success for equity research, so don't make the mistake of thinking that it is.
This does not mean that the function is useless. It just means you have to think about how to use it most effectively, and how NOT to use it.
I wonder if analysts pitch themselves to hiring DoR's by citing the $$$ of IB fees were generated from the names they covered. In biotech, GS and JPM do the most IPO's and follow on's (I think) so the biotech analysts there should (in theory) be the "most valuable" analysts to a given platform given the fees they "generated." But the analysts that get big $$$ moving between platforms are those that are highly regarded by buyside (II rankings).
I'd guess this is not talked about openly, but then again, I've never worked on the sellside.
I'm pretty sure that would not be cricket, and possibly illegal. I'm just talking about the practical utility of the function in real world terms.
The biotech guys try to take as much credit as they can, but their actual role in driving deal flow is minimal and they are very replaceable.
Echoing one of the former replies - I don't think you understand the actual job they do... there are reasons why the smartest and "cheapest" hedge funds pay millions of hard $ broker votes for research on top of the traditional trading commission. It's a dying industry for sure but most senior folks at respectable platforms know what they are talking about and the right people to talk to.
On top of what everyone else said re: job they do, you shouldn't take as an assumption they believe everything they publish.
Case in point - last year one of my 3 favorite analysts in a specific sector published his post EPS recap on a megacap which included taking his PT up 10% and reiterated his buy rating. Next day he called me and said hey not sure if you went through print yet but I think this is a pretty interesting short here, low quality beat, shifted these metrics around, played xyz off as immaterial when it's really a big deal. He had a corporate bus tour in 3 weeks and two years earlier when he d/g'd stock from a buy to a hold they cancelled on coming to bank's conference and cut him out of the que on the next two earnings calls.
I also had ERs explain to me that they only gave company X a buy rating because they've been told to have at least XX% buys in their coverage.
Their role is not to be correct about stock picks. They are relationship brokers.
I love when someone can summarize long ass paragraphs (see above) into one, concise, accurate sentence. Thank you.
One of these threads again?
Why are interns so bad at understanding how the world works? Imagine trusting the garbage data on TipRanks lol
Why are interns so bad at their internships that they actually believe TipRanks?
But really, live life more humbly. Just because you got an internship at a hedge fund (OMG buyside) doesn't mean you are now magically smarter than the sellside.
There is a paper that tries to explain it named "Analysts Are Good at Ranking Stocks".
It shares your observation on analysts estimates, and then tries to justify they can at least rank stocks using some basic factor modeling. Just as other commenters have said, the conclusion mentions as an explanation :
"The job-related incentives also tend to bias absolute forecasts, because the forecast target company might have business relationships with the brokerage firms issuing the forecast."
If they are at least good at relative valuation, you could hardly say they are bad at their job as a whole, even though their job includes adverse incentives. You're never sure with these academic research papers though, choose what you believe if you read it.
Passive wins because the majority of equity research analysts perform worse than the S&P.
Their job isn’t to beat the S&P bro. The fact that you don’t know this tells me you’re a college kid talking out his ass
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