A lot of people have (correctly) criticized ER analysts for producing unoriginal research, and not catching companies before they fail. These analysts are not dumb people. They are probably as smart as buy side analysts- they went to the same schools and worked for the same firms.
Why would you, as an ER analyst, stand against consensus? Your bonus is largely based on how well your forecasts line up with what actually happens. Institutional Investor does not award rankings retroactively.
Let's take the case of Allied Capital for the sake of familiarity. Allied employed fraudulent accounting practices, and was subsequently shorted by David Einhorn. The full story is detailed in his book, "Fooling Some of the People All of the Time".
Einhorn first publicized his short in 2002. The company's stock collapsed in 2007. Those investors that had not pulled their capital ended up seeing a nice payday.
Consider if Einhorn was a sellside analyst. He could be screaming "sell" and "fraud" all day, but he would be missing earnings estimates quarter after quarter. His price target would be multiple standard deviations from consensus. If Allied was one of just a few companies he covered, he would probably be out of a job before those 5 years were up.
Although he would eventually be proven right, it would be too late. The analysts playing along would have 5 years of rather accurate earnings estimates. They would also have better corporate access, and likely receive higher bonuses. Probably even better II rankings.
You often here "The market can stay irrational longer than you can stay solvent" but, in ER, the market can stay irrational longer than you can keep your job. So, ER analysts are not hacks...they are just rational players. You do not see banking MDs turning down deals because it would not help their client.
Full disclosure: I am just entering ER, so I could be way off. This is just how I see things.
golf clap. the system doesnt work. something about david einhorn. the sell side is an evil market manipulating herd of money hungry lemmings. and scene
Totally misjudging the feel of this post, man, nice job.
To OP...interesting post. Would be interesting in hearing what WSO's resident ER has to say.
what? everything op said is true and everything i said is true
What I was trying to say was that ER analysts are not intellectually dishonest, but rather good at responding to incentives. They are paid to forecast, not assess intrinsic value.
Nobody takes sellside forecasts seriously. Take the Allied example. They were really worth a few bucks per share. But issuing a 1 year estimate to that effect in 2002-2006 would have been wrong.
The buyside has the luxury of working on "eventually" if investors are patient and the payoff is high enough. The sellside doesn't. They have to make predictions for a specific time frame. Even if you were aware of a material misstatement, you would have to weigh whether or not the market would price it in that quarter. Same with fraud: will they get caught this quarter, or will they continue to report inflated earnings?
I am not saying the system is broken. Buyside analysts know what to use sellside analysts for. I just think that the "ER is full of hacks" sentiment might be misdirected.
There's certainly a range in quality among analysts. This holds even if estimates are pennies apart. The real value is demonstrated elsewhere anyways.
This is entirely correct. Ratings are complete fluff. If you know a company decently well, it's quite simple to outline bull and bear cases and illustrate positive or negative catalysts. Analysts tend to have Buy ratings on companies that will market or have the potential to market with them. I've even heard analysts (including II ranked, well respected guys) downgrade stocks to balance out their coverage because the company hadn't or wouldn't travel with them. Everyone in ER knows this but I think the general investment community would be disgusted by the reality and politics of ER. It takes a very rare and usually very senior person to have majority neutral or sell ratings and still be a top ranked, high commission analyst.
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