Free the Analysts From Ratings and Estimates

Free the AnalystsThis is an often written about topic, so let’s beat this horse a bit more, shall we? Every year, in the October issue of Institutional Investor magazine, the investment management community is surveyed to find out what they like most (and least) about brokerage research. In other words, what does the Buyside think of the research from the Sellside.

The categories to be sorted are a bit odd and incongruent in that some are products or accuracy ratings while others are more of a personality trait or eHarmony opinion. For example, “industry knowledge” is something of a subjective thought, and “analyst integrity/professionalism” is even worse in that I have no idea how that is calibrated. On the other hand, “analyst accessibility” is something concrete and can actually be measured with how much time an analyst allocates to direct client interaction. Our opinion is that the categories (like the analysis) is somewhat flawed due to these nebulous descriptions of attributes that range from personality, to personal (dis)likes, to actual products and analytical skills.

Regardless of whether it is a good ranking mechanism or not, it is always interesting to see how institutional money managers rate analysts. Not surprisingly (because it is the same every year it seems), industry knowledge and analyst access rate the highest. These two even trump integrity and professionalism, which means that if you are really knowledgeable in an industry and enjoy taking clients out to grab drinks every night, you really don’t need to be graced with great morals or manners.

Also not surprisingly, “stock selection” has once again come in dead last. Research delivery, earnings estimates, and financial modeling skills round out the bottom of the list. Now let’s take a moment to digest what the investment managers are once again trying to tell Wall Street. Let me see if we can boil it down in one succinct phrase…

STOP RATING COMPANIES!” screamed the professional money managers…

It is completely amazing how the people and firms who use Wall Street research more than everyone else have been screaming the same thing for years to a seemingly deaf audience. Investment managers want analysts who have deep industry knowledge and are looking for who can provide the best “Why?” analysis. They want access to these specialists and real time interaction and content. The belief that hedge fund managers are anxiously awaiting the release of an earnings estimate or initiation of coverage report from a top investment bank is insane. The survey, year in and year out, says that the Buyside just doesn’t care about those things.

Survey Oct 2008So if the Buyside doesn’t care about ratings and earnings estimates from the investment banking research analyst community, why provide them at all? The answer, is and has always been, retail. The investment advisors and registered representatives at the major investment banks have always used those ratings and the ill-conceived “Buy-Hold-Sell” reports to drum up interest, transactions, and the gathering of assets. It’s a failed model that has done more harm than good to individual investors for decades. If professionals view investment banking research ratings as useless, why do we keep allowing those ratings to be peddled to individual investors?

Now nothing I am saying is new, and it certainly isn’t a surprise. Most or our analyst friends at the major firms would absolutely love to stop having to produce 30 to 40 page research reports and quarterly earnings models that, in the end, don’t bring them any additional love (or compensation) from their institutional clients. It just appears that the machine doesn’t know how to turn itself off.

Unfortunately, it may be turned off by the collapse of the financial services industry. With Citi (C) possibly following suit of Bear and Lehman, who knows how many research houses will be left from the bulge brackets. In fact, Institutional Investor magazine might have some really interesting new categories of ratings next year. Perhaps “Still in Business” will be the top ranked attribute of investment banking research.

About Ockham Research 645 Articles

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

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