If you’re an investor, you probably know that Wall Street is full of analysts who study and report on what they believe is the health and stability of stocks as well as commodities and other investment products. Their primary duty is to give investors unbiased, tradable advice based on careful study of industry analytics as well as company specific metrics. It all sounds like a great service to the investment community but does the reality of the analysts live up to what they promise?
Analysts have to earn a living just like you and I so at the core of what they do lies the compensation they receive. Any time somebody is giving you advice, you have to ask the question, where are their loyalties? There are two types of analysts you should know about.
Sell Side Analysts
If you watch financial television, you are inundated with sell side analysts. These analysts often work for brokerage firms and tailor their advice to the clients of the firm. These are the analysts who publish the strong buys, holds, neutral, or sell ratings. Although they aren’t in the business of trying to get the firm’s clients to transact stocks, a brokerage firm makes money on the commissions generated from buying and selling products. Brokerages know that there’s a fine line between their analysts making recommendations frequently enough to generate commissions and making so many recommendations that clients no longer listen to them.
Also remember that sell side analysts’ recommendations are general in nature. They don’t take in to account your individual investing goals, level of capital, or risk tolerance. Just because they make a recommendation doesn’t mean that you should blindly follow it.
Finally, most analysts issue price targets based on their research. Nobody knows where the market will go tomorrow or a year from now. Price targets provide very little value to you as an investor. Use these analysts for their research and evaluate their findings for yourself. You can learn a lot about the stocks you own by reading their reports.
Buy Side Analysts
Buy side analysts are not highly applicable to the individual investor. Buy side analysts are employed by professional trading firms like hedge funds, mutual funds, and other large proprietary traders. These firms hire the best analysts in an attempt to get an advantage in the market. They don’t want their buy side analysts heading to CNBC to tell the world what they believe because the funds that employ them would lose their edge. These analysts are compensated by how much of an edge they give the fund that employs them. Great calls mean great bonuses. Bad or missed calls could mean unemployment.
Loyalties
Since the 2008 and 2009 collapse, analysts are now more tightly regulated and are more highly responsible for the ratings they place on investment products. Problems still remain, though. Let’s say that you owned a large company and used Citigroup for your banking needs. Citigroup doesn’t want to lose your business so their analysts might be less inclined to speak negatively about your company. New laws have made banks separate their investment banking division from their traditional banking in order to reduce the possible conflict of interest but as you read analyst reports, keep in mind that those conflicts of interest still exist.
Finally, you’ll often find that analysts are often late to make calls. An analyst may downgrade a stock on a day when their earnings report disappoints and the stock drops 10%. Like any other profession there are good analysts and bad analysts but remember that you are responsible for being your own analyst. Read their reports and use them as a jumping off point but don’t make decisions solely based on their information.
