Inside the “Black Box” of Sell-Side Financial Analysts
Wealthy individuals and professional asset managers of large funds know that a lot of money can be won or lost on the recommendations of financial analysts. Many people wonder what is within the “Black Box” of the sell-side financial analyst. How do they make their decisions? What factors influence their compensation? Lawrence Brown, Andrew Call, Michael Clement and Nathan Sharp interviewed financial analysts to gain a better understanding of the reasons for 1) covering certain companies and 2) making certain forecasts (http://www.shareholderforum.com/access/Library/20130300_Brown-Call-Clement-Sharp.pdf). Here are the 5 key secrets of the sell-side analyst.
1) How do you choose which companies to cover?
Many of the decisions made by financial sell-side analysts occur behind-the-scenes. While some assume that company coverage is based on objective factors to find the best-performing firms, the truth is that client demand is the primary factor.
2) What is the most important trait for analysts?
The Institutional Investor II All-American survey concluded that industry knowledge was a very important attribute for sell-side financial analysts. Analysts must compare competing firms in the same industry to determine which has the best chance of meeting its forecasts. Understanding the characteristics of the industry is critical.
3) What happens if you pick against the consensus?
The prevailing wisdom or consensus leads some bankers to simply follow the herd. Unfortunately, the herd is not always right. One of the survey questions asked what would happen if your stock forecast or recommendation is much lower than the consensus view. Most would expect some negative consequences – 16% said they might lose “access to management” and 14% said they might be “frozen out” of a conference call Q&A session. But it is not for the “weak of heart.”: more than 21% said there would be an “increase in your investing clients’ perception of your credibility[,]” for picking against the consensus.
4) Broker Votes Influence Analyst Compensation
While the success rates of stock recommendations are important, the most important factor in a financial analyst’s compensation is something called the “Broker Vote.” The brokers and clients vote on whose research has been the most helpful in generating business according to 83% of respondents. In the sell-side analyst field, if you are proficient, you will be rewarded handsomely.
5) Personal Phone Calls From CEOs
Being an analyst is exciting due to the close contact with some of the most powerful CEOs. After a group Q&A conference call, the best financial analysts have private phones calls with top management. This enables both parties to be more open, honest and forthright in discussing the company’s fortunes.
Bottom-line: Delivering Quality Research and Independence
The “Black Box” of sell-side financial analysis is based on providing quality research and delivering business for brokers. In the long run, independence is a key factor that makes experts stand out. The leaders of large corporations are in close contact with sell-side financial analysts.
- Real life of an Equity Analyst. Buy Side (alphabanker.wordpress.com)