Wall Street sales research is a key part of the financial markets, conducted by analysts working for brokerage firms, investment banks and other institutions. These analysts evaluate companies and make recommendations to help investors—mostly institutions—make informed decisions. Research on the buy side (wealth management firms) is a completely different kettle of fish, produced by the institutional investors themselves and not intended to be shared, distributed or otherwise sold and intended solely for the use of that firm’s own money managers. Here’s a quick breakdown of how the sell-side research process works and how to use it to your advantage: The Role of Sell-Side Analysts Analysts are financial professionals, often with qualifications such as the Chartered Financial Analyst designation, who conduct in-depth research. about public companies. In health research, it is not uncommon to find analysts with medical degrees. Sometimes analysts come from the private sector. The work includes analysis of financial statements, industry trends, management effectiveness, company strategy, and macroeconomic factors affecting supply and demand. The purpose is to evaluate a company’s future performance and offer investment recommendations to the investment bank’s clients, whether institutional investors such as pension or hedge funds, mutual funds, insurance companies, or retail investors. Research Reports An analyst’s published research report may include an overview of the company with basic information about the company’s business, products, and position in the relevant market. This is especially true when an analyst first begins researching a particular company or industry. Beyond the basics, the report will review the company’s financial health and analyze the income statement, balance sheets, and cash flows. This will include the analyst’s own financial model and earnings estimates for future years; arrived; net profit; income adjusted for one-time items; earnings before interest, taxes, depreciation and amortization (EBITDA); cash flow; and many secondary criteria. This analysis will lead to a discussion of valuation using techniques such as future cash flows discounted back into today’s dollars; price-to-earnings ratio based on current results and expected future performance; and other criteria for deciding on intrinsic value. Against this backdrop, an investment thesis will offer arguments for why a stock is a good or bad investment, as well as highlight the possible risks of the thesis that could affect the performance of the business or its stock price on the open market. The report culminates with a recommendation to buy, sell or hold a security and provides a target price that is expected to be realized within a specified time, usually within the next 12 months, although sometimes longer. Recommendations Ultimately, the client wants to know whether he should consider buying, holding, or selling a stock using the analyst’s opinion to make an investment decision. A “buy” recommendation means that the analyst believes the stock is undervalued and is likely to rise in price. Variations include “strong buy” or “outperform” to signal an even higher or lower degree of confidence, depending on a particular firm’s own specific nomenclature, or simply that the stock will perform better than other stocks in its industry or on the market as a whole. A hold recommendation simply means that the analyst believes the stock is fairly priced around today’s price and offers limited room for growth, so it is recommended to maintain the current position but not buy more or sell it. Variations on this theme include ratings such as “neutrality” or “market efficiency.” The rarest call on the street is “sell,” where an analyst is essentially saying that a stock is overvalued today or will soon face downside risk. Variations here could include “strong sell” or “underperform”, which again means more or less confidence, reflecting the company’s internal hierarchy, as well as whether the stock will underperform its industry or the broader market. Analyst recommendations influence stock prices every day, especially if the analyst or her firm is highly reputable or considered to have expertise in a particular area. It is also often the result of marketing and sales by investment bank brokers and traders who alert the firm’s clients to a particularly bold call from the research department. Like many things on Wall Street, sometimes it’s just a matter of trust. A stock may rise after a positive report and a buy recommendation, or decline after a negative report and a sell recommendation, simply because many investors trust the analyst’s expertise and follow her advice. A wink is as good as a nod. Keep in mind that sell ratings are so rare on Wall Street that often downgrading a stock to “hold” from “buy” (or “neutral” from “outperform”, etc.) is interpreted as veiled advice to get rid of the holding entirely . In other words, like a “soft sell.” It’s a diplomatic way for analysts to express a negative view of a stock without appearing too pessimistic. How can “retention” become “sale”? Because of potential conflicts of interest, when an investment bank wants to be hired to help a company sell shares or advise on a merger or acquisition, and an analyst issues an opinion on the sale, it could jeopardize that relationship. Or because an existing client, such as a pension fund or hedge fund, holds a position in the stock and a formal recommendation to sell would harm their portfolio. This is because a sell recommendation could deprive the analyst of contact with the company’s management or otherwise jeopardize the flow of information from the company. As a result, “hold” recommendations can be code for “sell,” and their use as a catch-all category for stocks that analysts say investors should avoid, but without the stigma of an outright “sell,” has increased over time. “Therefore, while perhaps 50% to 60% of all recommendations on Wall Street from all analysts are buy stocks, somewhere between 30% and 40% may be hold advice, and only 5% to 10% are selling. Contrarian indicators. Sometimes analyst recommendations can also act as a contrarian indicator. Just as investor sentiment indicators can signal a possible price high when sentiment is too bullish, and a possible day when sentiment is too bearish. The same can be said for sell-side research on Wall Street. When a large majority of analysts give a buy rating to a stock, it may mean that all the potential good news is already baked into the stock, meaning there is little upside potential. Or, when analysts are bullish. bearish on the stock and only recommend holding or selling, this could mean that expectations are low, most or all of the bad news has already been reflected in the stock price, the stock is potentially undervalued and sentiment may improve. Analysts are also sometimes late. By the time a stock receives a large number of buy recommendations, it may already have risen in price. Conversely, by the time a stock receives multiple hold or sell recommendations, the price has already fallen. Finally, investors may also view too many buy ratings as a reflection of analysts’ desire to curry favor with the companies they cover by helping the investment banking side of the business attract clients and drive business. Rules, Compliance and Ethics As a counterbalance, analysts and their firms are now subject to a variety of rules aimed at promoting transparency and reducing conflicts of interest. This was largely a response to the dot-com bubble of the late 1990s and its subsequent collapse in the early 2000s. At the time, many sell-side analysts were criticized for overly optimistic research reports, which were blamed for contributing to the bubble. A wave of regulatory reforms followed, including the Sarbanes-Oxley Act of 2002. Among other provisions, the Sarbanes-Oxley Act requires analysts to disclose any potential conflicts of interest. More formally, the 2003 Global Analyst Research Compact arose from investigations by the Securities and Exchange Commission and state attorneys general into conflicts of interest between the securities research side and the banking side of investment banks. The $1.4 billion ($2.4 billion in 2023 dollars) settlement ordered the nation’s 10 largest investment firms to pay hundreds of millions in compensation to injured investors and hundreds of millions in fines, and agree to reforms in the way they do business to prevent the future. conflicts. As part of the settlement, Merrill Lynch Internet analyst Henry Blodgett agreed to a “letter of acceptance, denial and consent” that stated that Merrill, for three years, “published research reports on two Internet companies that violated provisions of federal securities laws.” anti-fraud papers and published research reports on five other Internet companies that expressed views inconsistent with [its] “These rules require, among other things, that published research reports be on a reasonable basis, present a fair picture of investment risks and rewards, and not make exaggerated or unsubstantiated statements,” according to the agreement. Transform your portfolio with expert analyst ratings! Click here to join CNBC Pro.
