It’s unclear whether more veteran stock analysts are quitting or fewer newbies are coming in, but staffing levels at the world’s top stock-research shops are on the decline.
“Whereas certain names might have had six analysts following them, now there might be three,” said Westcourt Capital President David Kaufman to the Globe and Mail. Numbers from Britain-based data provider Coalition, which were cited in the Financial Times, also revealed that the number of stock and bond pickers at the 12 biggest investment banks in the world has decreased 10% over the past four years.
The thinning numbers suggest that the investment industry is shifting away from sell-side research – a business beset by low demand and reputational challenges.
Investment bank and broker research profitability has been degenerating ever since the dot-com bubble burst in 2000, when new regulations sought to separate research and underwriting functions. Before that, equity research had been used to generate underwriting revenues by supporting the investment banking business with favorable research. Analysts were incentivized to be bullish rather than right; in 1999, for instance, analysts at Merrill Lynch came out with 940 “buy” stock ratings and just seven “sell” ratings.
The global financial crisis squeezed the industry further as fewer portfolio managers, who were hurt by the crash, could afford research. A shift toward fee-based wealth management has not helped: “The greater the number of assets in fee-based accounts, the less churn, and the incentive to create reports in the first place is much lower,” Kaufman said. “You don’t need the idea du jour to generate sales commissions.”
Analysts’ credibility remains in doubt as analysts are still seen to lean toward bullishness. Considering 805 Canadian-listed stocks with at least one analyst rating them, as tallied through Bloomberg data, one would find only 225 “sell” ratings out of more than 5,400 total recommendations. “It’s rare to see analysts stick their necks out,” said Foyston, Gordon & Payne President and Portfolio Manager Bryan Pilsworth.
Kaufman noted that a negative analysis of a stock that proves to be right can enhance a stock picker’s reputation, but “does virtually nothing” for their employer. Therefore, reading a positive stock recommendation should be taken as a “grain-of-salt exercise.”
Still, sell-side research can be valuable. Like snowflakes that add up to an avalanche, the consensus on a given stock can provide valuable insight into how it might move, according to Pilsworth. “Even though sell-side research can be poor, it does have an influence in the market,” he said. “You have to understand how that works.”
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