The Farce Of the Sell Side

Posted by UpsideTrader
on November 13th, 2011

A sell side analyst works for a brokerage firm and evaluates companies for future earnings growth and other investment criteria. They sometimes place recommendations on stocks or other securities, typically phrased as “buy”, “sell”, or “hold.” They are incentivised by offering their recommendations to institutional investors clients, as well as by seeking investment banking deals with the firms they cover, although the latter is subject to significant regulatory restrictions, particularly in the United States. A proper title for some sell-side analyst is Equity Research Analyst.

Well that’s the broad definition of what an analyst is. Those of you who read this blog know that I have almost zero regard for these ivory tower charlatans. I never did. The analyst, the investment bank and the issuer had become way too incestuous. Way too buy and hold for me anyway and not much accountability after horrible calls. Not that long ago, an analyst would put a buy on a stock and presto, business came from the issuer to the investment bank. The analyst was given a bonus and a high five and then began work on another strong buy for yet another issuer. Rinse, repeat.

There were many other layers of self dealing, and the SEC did finally did step up and make some changes, but some things just stay the same. Let it be known that I have zero use for the SEC either.

Analysts are part of a herd or pack mentality. They zig and zag together. They chat and text together, they drink at the same watering holes. Did you ever notice that many times an upgrade or a downgrade on a stock happens on the same day or a day apart. Koinky dink? It’s all about the first guy that blinks and none of them want to be left behind on a call.

Mike Mayo is a bank analyst that has made some sector calls that have been completely opposite of the herd. I found this excerpt from his new book very telling.

Analysts are supposed to be a check on the financial system—people who can wade through a company’s financials and tell investors what’s really going on. There are about 5,000 so-called sell-side analysts, about 5% of whom track the financial sector, serving as watchdogs over U.S. companies with combined market value of more than $15 trillion.

He goes on to say:

Unfortunately, some are little more than cheerleaders—afraid of rocking the boat at their firms, afraid of alienating the companies they cover and drawing the wrath of their superiors. The proportion of sell ratings on Wall Street remains under 5%, even today, despite the fact that any first-year MBA student can tell you that 95% of the stocks cannot be winners.

I remember the crash like it was yesterday, and I remember how the great majority of analysts reacted to it. They did nothing until it was too late. They watched and watched until the first one blinked. Then they all sold. The herd ran. Always the herd. It was way too late, but they sold. About 80% of mutual funds lost money that year. All were petrified longs waiting for that “call” from the ivory tower. The call came, but the damage was done.

Here is a link to the Wall St. Journal piece. I think it is not only a great read, but a must read.

$XLF, $SPY

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