An analyst reflects on the decline of the sell-side business model
Based on my history of doing and using equity research, I have four main conclusions about the business. Last week I explained that sell-side research remains plagued with conflicts of interest, as it’s the bankability of sector/industry coverage that determines where broker-dealers invest in research. Here is my second point:
2. Independent equity research can improve active management
Institutional investors vary greatly in strategies, ranging from massively diversified to highly concentrated. Regardless of whether the strategy is deep and narrow, or wide and shallow, investors always need information flow and new ideas. Asset prices are inefficient and inefficiency can persist despite the stock market’s awesome collective intelligence.
Why was one able to buy shares of AMN Healthcare Services at $10-$11 in spring 2014 and then sell them at $40 within 14 months? Why did the stock price of Monster Worldwide reach $25 in 2010, only to lose 80 percent of its value within two years? Why did LinkedIn shares dip below $100 late in 2012, then soar past $250 within nine months (and return to $100 in early 2016)? Did you buy Facebook (recently $150 a share) at $18 (2012), $23 (2013), $55 (2014), $75 (2015), or $100 (2016)?
Good, independent equity research can help investors recognize these extraordinary opportunities. An analyst focused tightly on a group of related stocks develops industry and company-specific knowledge and historical perspective. An equity analyst is of greatest value in those moments when the market’s herd behavior detaches stock prices from companies’ intrinsic value. It happens more often than finance theory claims it should.
Investors used me to help them get to speed quickly on the stocks I followed. Analysts’ written reports, company filings and conference call transcripts typically dance around – but don’t confront – the most important qualitative factors. Written research is non-confrontational; Financial Industry Regulatory Authority standards push analysts to use muted language and conform to the tradition of blandness. Moreover, sell-side analysts must be ever-conscious of relations with company executives. Investors have made it obvious: those relationships are analysts’ most important assets.
That is why the live, analyst-to-investor conversation is invaluable. The two-way conversation between an intrigued investor and an experienced analyst provides swift, dynamic information flow that speeds the investor toward making the call on a stock. Written reports can be so wishy-washy that they are counterproductive. A research analyst brings the greatest value with current information in context and real-time prices. Regulators have been moving in the opposite direction, making it harder for analysts to adjust their views without going through the often drawn-out publishing process.
Sometimes I wished my reports were not documents but dashboards, updated constantly with current prices, allowing me to change opinions and nuances and have those thoughts instantly distributed. The world operates at that speed. We need to catch up.
Randle Reece is a senior financial analyst and former IRO based in Nashville
