Image Source: Sam Valadi

“New Wall Street Conflict: Analysts Say ‘Buy’ to Win Special Access for Their Clients… Securing face time for investors with top executives has become a vital revenue source for securities firms…” – Wall Street Journal, January 19, 2017

By Brian Nelson, CFA

It is no surprise that buyside firms tend to prefer sell-side institutions that can get them access to the head honchos of companies. Buyside analysts and portfolio managers are talented, and some may have even come from the sell-side (in a previous life, if you can get them to admit it). In many cases, they know exactly what they’re doing (how to analyze a company or industry), and perhaps they have been doing so for decades. The buyside may even know how to “read” management better than any other sell-side analyst covering the stock.

It stands to reason then that what many buysiders really want is not necessarily the research or opinions from the wirehouse brokers, but access to management through those wirehouse brokers. This is where it appears most sell-side analysts are earning their keep these days, or at least a meaningful portion of it--not necessarily in the quality of the analytical work or research, or accuracy of the research recommendation, but in setting up meetings for their clients with managements of the companies they follow. How bad has this gotten? Well, look at what Bloomberg had to say, “Wall Street Analysts Give Investors What They Want (January 20, 2017)”:

If you believe that the job of a sell-side analyst is to tell people which stocks to buy and which ones to sell, you need to stop believing that right now, because it is not true. You shouldn't be embarrassed about getting this wrong; lots of people did. For instance, this guy thought that, and he actually was a sell-side analyst:

David Strasser, a former retail analyst at Janney Montgomery Scott LLC, says some investors told him they had little interest in his research and were only paying for meetings he could set up with companies.

“I wanted to be valued for my analytical abilities, but arranging meetings became such a critical part of the job,” says Mr. Strasser, adding that he was sometimes asked to sit outside the room so investors could ask questions without him.

……

Many securities firms tally the number of times their analysts take company executives on the road to meet clients and use the number to help decide analysts’ annual bonuses.

At some firms, as much as one-third of analysts’ yearly pay can be tied to corporate access, says James Valentine, the founder of training and consulting firm AnalystSolutions LLC…

…there is…the dumb simple narrow question of: Which is more important, the corporate access, or the Buy/Sell/Hold recommendation? And on that question, there is just no doubt. Clients want the access, and are willing to sacrifice Buy/Sell/Hold accuracy to get it:

Analysts’ relationships with company executives, including the ability to line up private meetings for investor clients, have become an increasingly vital revenue source. And that is increasing the pressure for analysts to be bullish on the publicly traded companies they follow.

……

And investors do have to sacrifice some Buy/Sell/Hold accuracy for the access, because some companies will explicitly refuse to do client meetings with research analysts who have Sell ratings on their stocks.

“It’s a decision I have to make on my sell-rated stocks: whether I will forgo the opportunity for corporate access, which clients will explicitly pay for,” says Laura Champine, a retail analyst at Roe Equity Research. Some previous bosses at other firms told her to “just drop coverage” instead of putting out sell ratings, she says, while declining to comment on where that happened.

And so "just 6% of the roughly 11,000 recommendations on stocks in the S&P 500 index are sell or equivalent ratings."

Who is this hurting? Small-time investors.

The worry is that small-time investors don't understand this system, and don't benefit from it. Big institutional investors get to meet with corporate management, which they like, because it is useful; they discount the Buy recommendations. Small-time retail investors -- and even small institutions -- don't get the benefit of corporate access, so they just assume that the research is about the Buy/Sell/Hold recommendations, and that they should buy all the stocks labeled Buy.

Analyst recommendations often carry weight with small investors, says John Bajkowski, president of the American Association of Individual Investors, a nonprofit group with 180,000 members. Most retail investors tend to lack sophisticated financial data and seldom dig through corporate filings, he says.

What’s the answer for investors looking for good research, analysis and unbiased opinion? Independent research.

As you know, Valuentum does not provide recommendations on stocks, or get compensated for providing client access to management teams. Further, unlike rating companies and the brokerage house/investment banks, Valuentum’s entire revenue stream is member-funded, not company-funded--meaning that the only thing we are incentivized to do is tell the truth (in how we interpret it) and be as transparent as possible.

Mutual funds don't pay us to use their "star ratings" like Morningstar (MORN), companies don't pay us to rate their debt like Moody's (MCO), and firms don't pay us to sell their stock like the investment banks such as Morgan Stanley (MS) -- and where others, for example, “Deutsche Bank Analyst Kept Some Doubts To Himself (February 2016),” may feel pressure to hold things back, we put everything on the table. All we get paid to do is tell things how we see them--and when it comes to serving our members, how can there be any other way?

That’s the value of independent investment research. That’s the value of Valuentum.

Securities Research: DNB, FDS, MCO, MORN, SPGI, TRI, VALU

Related Securities Firms: DB, GS, MS, JPM, UBS, C, BAC