Paul Kedrosky sparked a heated debate when he suggested we shouldn't trust analysts who don't own the stocks they rate as "buys" or short their "sells." Evan Newmark at DealJournal chimed in with a similar thought: "A better way to instill investor confidence in analyst picks would be for them to bet their own money, either pro or con." Felix Salmon bucks the trend today by arguing that (1) analysts are irrelevant because institutional investors ignore analysts' buy/sell recommendations, (2) owning or being short the stocks would introduce bias into analysis and (3) analysts aren't any good at picking stocks, so encouraging them to own their picks wouldn't improve things.
We're still outside observers in this debate but we notice that Felix's first and last points might be ameliorated by analysts buying and selling in accordance with their picks. Institutional investors might be more inclined to follow stock picks of analysts if they knew the analysts were incentivized to pick correctly because they had skin in the came. And analysts might get better if they stood to gain and lose based on the quality of their picks.
The guy who started all this, Kedrosky, has a much longer response here.
Posted by guest , Jun 25, 2008 5:40PM
it would be a self fullfilling prophecy if an analyst buys a stock he recommends, since everyone will then buy it as well and as a result it would go up.
Posted by guest , Jun 25, 2008 5:43PM
I think it could be argued on both sides. On one side I'd want the analyst to have "skin in the game", but on the other I would be concerned that they would hype stocks for the sake of their PA. I do believe that they should be compensated based on how well their recommendations do relative to their sector and the overall markets...
Posted by Anal_yst , Jun 25, 2008 5:48PM
Or, you could just change the compensation scheme to reflect exactly how accurate the analysts are. Duh.
Posted by guest , Jun 25, 2008 5:52PM
A stock is going to go where it's going to go, grasshopper.
Posted by Anal_yst , Jun 25, 2008 5:54PM
Shit, didn't see 5:43...anyway, to elaborate, I think the issue is incentives here. Now, (and please correct me if I'm wrong), being a highly-ranked (II, etc) analyst matters alot in how an analyst progresses in his/her career, gets paid, etc.
The question firms (and their clients) need to ask, is whether they're paying for the analysts' ear when they need it (e.g. winning II points by sucking up to/kissing your client's asses), or are they are paying for the analysts to make accurate, timely recommendations.
One problem here, is that presently at most banks, analysts have to cater to both institutional and retail investors alike, when each party (as well as subsets within each party) have vastly different needs and levels of sophistication (on the whole).
Perhaps a breaking down of research teams into one that serves client group A (institutional), and client group b (retail) is in order?
Posted by cauxion , Jun 25, 2008 6:13PM
Simple solution.... Bonuses should be based on the percentage of stock picks they get correct. Problem solved!
Anything else and you are asking for trouble.
Posted by merkin capital partners , Jun 25, 2008 6:44PM
and what is "correct"?
Posted by guest , Jun 25, 2008 6:44PM
I agree with all the compensation tied to accuracy comments. Another problem is that many analysts focus on a particular business or industry, and asking them to take a number of meaningful positions in that specific area leads to analysts with poorly diversified portfolios. As an investor, I would refuse to become an analyst, even if I felt I was a great stock picker, because of the industry (or whatever)-specific risk that I don't have an opportunity to hedge against if my portfolio is tied up in my picks.
Posted by guest , Jun 25, 2008 7:15PM
One of the good things about analysts NOT owning their covered stocks is that they may "think outside the box" a bit more because they don't have a financial interest. To that effect it's not a bad thing for them to not own their names.
That being said, we make most of our dough by arbitraging what the sell-side thinks and what we see in our own models...if analysts had skin in the game it may cut down on the thought creation.
It's like playing poker with chips, but with no money behind them.
Posted by guest , Jun 25, 2008 7:32PM
Which dept pays for the research? If it's IB..no, really??...then the anaylst is there to give coverage to the money makers.If they did have some skin on the line, betcha we'd all see fewer 'Neutral" ratings.
Posted by guest , Jun 25, 2008 8:48PM
This is the dumbest shit i've ever heard. if you're waiting on some one to tell when to buy and sell the stock you're already fucked. The analyst is supposed to keep track of the industry keep you abreast of what's going on more or less. maybe they can tell you if things are doing relatively better or worse... maybe. beyond that, fucking forget it. I remember back when Verizon bought MCI I wanted model the industry and took a look at some initiating coverage reports for MCI when they emerged from BK. All the fucking analysts had price targets of like -$30 a share. Fucking seriously, negative price targets, like there was no such thing as limited liability. Somebody needs to introduce those clowns to the =max() function. And not to mention these were the same fucks who had valued the company at over $100bn 3 years ealier. Gramted capitalizing your operating expenses will make it rain fcf... But now the same company, with huge fixed assets, was emerging with a greatly decreased debt load and NOL carry forwards as far as the eye could see and yet it was worth negative dollars?
The analysts are reporters not investors, they can tell you where the stock has been not where its going. Which is fine, you need to know where you've been. But, having analysts invest money in the stocks they cover, that's the colonels' original recipe for disaster.
P.S. The SEC should pass a regulation banning price targets.
Posted by Cincinnatus C , Jun 25, 2008 9:06PM
@8:48...alot of discretionary accounts definitely depend on the analyst buy/sell recommendations. the major brokerage houses pitch these bullshit 'chief economist ideal portfolio' type of thing that allows for this kind of churn n burn.
and yes, those investors are getting fucked.
Posted by guest , Jun 25, 2008 9:46PM
the value of the analyst is not the buy/sell recommendation. it's the analysis that goes into their pick. no one should structure their portfolio based on analyst recs. tying comp to picks will never happen b/c they can easily make picks driving a stock higher, thus skewing the efficiency of the market. people say these things like others haven't thought of it before.
Posted by Anal_yst , Jun 25, 2008 10:47PM
@ 848 (and onward) -
All definitely good points. The problem is that (mostly retail I'd imagine/hope) investors ARE using analyst recs as the be-all, end-all. whether its in a "model portfolio" as Cincinatus C pointed out, or in their own self-directed accounts.
As 8:48 points out, this opens up arb opportunities, which is good for traders and astute investors, bad for the sheep that blindly follow analysts' words verbatim, but thats what's supposed to happen (sheep get slaughtered and all that).
I do like the idea 8:48 points out about the SEC at least looking at price targets. While eliminating them outright might be an uphill battle, perhaps there's some opportunity to improve the process to protect aforementioned sheep from themselves and whatnot. w/e, enough of this
Posted by guest , Jun 26, 2008 6:39AM
Nobody - retail or institutional - listens to analyst. Buy side wants (passively) their models, and sell side uses the model / color for trades. The only incentive is when the sell side wants to arrange dinner between buy side and some CEO, it helps if the research out on the firm is not radioactive.
Posted by guest , Jun 26, 2008 8:20AM
The analyst is compensated more on client vote (the internal vote done by the buy side clients that they use to allocate commissions and that is distributed to each of the sell side research depts) than II these days, of course there is a good amount of correlation between the two naturally.
My point is, though, that as a research dept, if your analyst is winning commissions as dictated by the client votes why would you ever want to compensate him/her less just because he is wrong a lot?
Posted by guest , Jun 26, 2008 8:23AM
The problem with the debate is both Felix and Paul don't understand what investors use analysts for and how they get paid. Investors use analysts for newsflow, valuation frameworks, and consensus. Buysiders are making their own stock picks, but they spend time with analysts vetting their models and thoughts because ideally, the sell side analyst should know the companies they cover more in depth than most buysiders. And analysts get paid mainly on equities trading revenue and overall bank performance. Trading revenue is based on flow (i.e. how visible your research is in the market) and using the firms balance sheet to facilitate trades (i.e. getting your traders comfortable with risk). Analysts aren't paid directly for stock picks. Some of the best analysts on the street could have no ratings or price targets but still be very productive because of the valuation framework they provide for the street.
Posted by cauxion , Jun 26, 2008 8:34AM
I have to admit, I've only read a handful of sell-side analyst reports. When I used to do reports for my firm they were actually pretty in-depth and reliable... of course I was on the buy side.
I mean come on, we all know sell-side analysis is a joke. It's not a big secret to those that know anything about how the system works.
A bunch of us analysts (buy and sell side) used to get together and laugh about how ridiculously stupid people had to be to base their trading decisions off of these reports.
Posted by guest , Jun 26, 2008 9:07AM
the only reason these analysts even have price targets and shit is because of crap NASD regulations requiring shit like that to be able to cover a stock