What in the World is a
While the term "analyst" is one of simpler ones to come out of the jargon-infested world of Wall Street, its very simplicity often causes new investors a great deal of confusion.
It's actually pretty easy: Analysts analyze. They are responsible for determining the value of a stock, based upon its current valuation in the market and their expectations of the company's future earnings per share. Just to keep you on your toes, though, they've been divided into sell-side analysts, also known as Wall Street analysts, and buy-side analysts.
Sell-side analysts (there are roughly 4,000) are employed by brokerage firms to follow specific stocks in industries in which they have an expertise. They research every angle of a company and attempt to predict future earnings per share, maintain a recommendation on the stock (the self-explanatory "buy," "sell" or "hold") and look for possible investment banking opportunities for the companies, such as mergers or other strategic acquisitions. Sell-side analysts sell their investment ideas and picks to investors via the brokers at their firm.
In general, when you're researching a stock or when you read an article detailing an event that could impact the earnings of a company you hold, sell-side analysts are the ones being quoted. They're the ones who make Institutional Investor's "All Star Team" and are on television talking about the industries they cover.
Buy-side analysts, on the other hand, work for money management firms -- such as mutual funds, investment advisers, family trusts and pension funds -- and currently number more than 22,000. Their job is to find stocks that their institutions can purchase and make a profit on.
Now, here's the rub: If you look at a cross section of sell-side analysts picks, you'll find an unusual number of analysts having posted "buy" or "strong buy" monikers as opposed to "hold," "sell" or "strong sell" on the stock of companies they follow. This pattern has been so rampant over the last few years that it has prompted several articles in the business press questioning the usefulness of sell-side analysts' predictions.
Some have attributed this disparity to the lengthy strong market rally, fostered by unprecedented interest in investing by the general public. However, you'd likely find the same conditions even if we weren't living under the sign of the bull.
Why? Sitting between investment bankers, who find companies to take public and brokers, who need to sell the stock of the companies that the brokerage firm's investment bankers have taken the time to underwrite, sell-side analysts are stuck firmly between a rock and a hard place. If an analyst has begun following a given stock, then that company either has a relationship with the brokerage firm via an underwriting or the firm can execute trades in the stock.
If you believe a brokerage firm or investment bank that has had one of its analysts issue a negative recommendation on a company is ever going to get any more investment banking business from said company, I've got a bridge I'd like to sell you.
Defenders of sell-side analysts argue that the pressure felt by the investment banking division is balanced by the need for brokers to supply their clients with solid investing ideas. Analysts can't be pushing inferior stocks because brokers would eventually suffer the wrath and loss of business from toasted clients. But, since brokers make money on commission, analysts may feel pressure to recommend stocks that have high trading volumes as this allows more chance to trade and more room for high commissions.
Who's an investor to trust?
Well, while buy-side analysts may seem less biased since they not only take into account sell-side analysts picks, but also do first-hand research and, by acquiring large blocks of stock, are often privy to company inside information, your chances of getting their well-guarded picks are pretty slim. Money managers zealously protect those picks since they're footing the bill for the analysts' salary and travel.
So, what's an individual investor, without a personal team of analysts, to do?
As with most stock-related questions, the answer is research. By following a company and its analysts carefully, you'll be able to tell which Wall Street analysts generally come closest to the mark. Schroder's David Londoner, for example, follows the media industry and is well known for speaking his mind instead of kowtowing to CEOs playing a line.
Beyond figuring out the relatively few sell-siders willing to go out on a limb, check out analysts' consensus reports published by groups such as First Call. They compile and average the earnings estimates of sell-side analysts for the companies the analysts cover. First Call publishes this information prior to the company issuing its estimates of earnings for that given quarter.
Ultimately, following analysts is similar to tracking stocks; know the analysts that cover the stocks you own, and look at the other companies they follow. Available in most libraries, Nelson's provides reference books that list companies, the analysts that cover them and what their track records are. It takes some work, but all informed investing does.