Four for Friday ~ The Role of Sell-Side Analysts

The “star analyst years” on Wall Street have been the topic of two postings here.  The first provided the overall backdrop of the times and the key players, while the second was based upon personal accounts of what it was like to be “in the belly of the beast.”

Given the availability of sell-side ratings, recommendations, and target prices, buy-siders and academic researchers alike have analyzed the “performance” of analysts (although those studies don’t capture the value of other inputs that they provide to the decision processes of investors).  How will their role change going forward?

Great quarter

Quarterly earnings conference calls feature analysts asking managements questions — and offering comments to them, usually of the puffy variety.  In “Great Quarter, Guys,” Marc Rubinstein wrote about the dynamics of the calls and how the title phrase and others like it indicate a trade of “public debasement in exchange for private access.”  Despite the mocking of that practice by others, it has increased in frequency rather than gone away.

(Natural language processing has been used for some time to evaluate the content of information provided by managements on those calls.  It is now being applied to the analysts and their questions as well.  One example.)

Robot analysts

Will robots be better as analysts than people?  From “Human versus Machine A Comparison of Robo-Analyst and Traditional Research Analyst Investment Recommendations”:

Robo-Analysts produce a more balanced distribution of buy, hold, and sell recommendations than do human analysts and are less likely to recommend “glamour” stocks and firms with prospective investment banking business.

Automation allows Robo-Analysts to revise their recommendations more frequently than human analysts and incorporate information from complex periodic filings.

While Robo-Analysts’ recommendations exhibit weak short-window return reactions, they have long-term investment value.

There’s also a cost consideration that could come into play, in the same way that Refinitiv forecasted the increased use of robot analysts in the investment banking department.

Non-deal roadshows

A column from Matt Levine offered “a basic model” of sell-side research.  Of great importance in that model are the meetings between institutional investors and company managements:

Wall Street research analysts are largely in the business of arranging those meetings:  They are intermediaries between corporate managers and big institutional investors, and so they set up meetings between them at investor conferences, “non-deal roadshows” (where a company’s executives fly around to meet with investors), etc.

Levine linked to a paper that studied such meetings and concluded:

Non-deal roadshows (NDRs) are private meetings between management and institutional investors, typically organized by sell-side analysts.  We find that around NDRs, local institutional investors trade heavily and profitably, while retail trading is significantly less informed.  Analysts who sponsor NDRs issue significantly more optimistic recommendations and target prices, coupled with more “beatable” earnings forecasts, consistent with analysts issuing strategically biased forecasts in order to win NDR business.

All evidence (here and elsewhere) suggests that Reg FD isn’t doing what it was supposed to do.

Following price

In February, Kris Tuttle wrote about Vertiv Holdings for Almost Daily Candy.  The company had reported a bad quarter due to inflation and supply-chain issues and the stock got hit hard.  That caused some analysts to slash their target prices and change their ratings.  Tuttle questioned the modeling and investment thinking behind those moves.  With many years of experience on the sell-side himself, he noted:

To be fair sometimes you have to do this so that you can have some impact later when you upgrade the stock in a few months at $17 and increase your price target back to $25.  That’s part of the game but not very useful for investing.

Ignoring the specifics of this case, how do “investing” and “the game” intersect for sell-side analysts when they adjust ratings, targets, etc.?  For example, the evidence shows that analysts move their target prices in response to stock price movements, even when nothing fundamental has changed.  Do you think robot analysts would react that way too?