I am not one of those people who decided they wanted to be a pilot when they were 7 and shaped their life path to fit that goal. I believe that, unless you’ve actually tried something, you will not really know what it is like and you will definitely not know if it fits you.
Therefore I was very happy when I got the chance to try my hand at being a sell side analyst, admittedly for a short time. I would like to share some of the lessons I learned and why I think I will not pursue this as my career path in the future. But let’s start from the basics.
What does a sell side analyst do?
A sell side analyst, who usually works for a broker, is tasked with coming up with new investment ideas and developing a research report covering one or more companies, usually in a particular industry. The sell side analyst typically follows either a top down or a bottom up approach to arrive at a recommendation. In the first case, an industry trend, such as for example the Internet of Things or the rise of fast casual dining, will provide the first basis for a stock screening. In the second case, the analysis starts from a single company.
During the research and after the recommendation has been written, the analyst will closely follow the company, interacting with HR representatives, reading the news and speaking with industry experts, to continuously update her findings.
The ultimate goal for a sell side analyst is to convince institutional clients to buy shares in the company and to direct their trades through her employer’s trading desk.
My experience
My brief experience as a Sell side analyst taught me much and more. I appreciated the chance of building models and coming up with investment ideas and I enjoyed getting to know new sectors and companies and their financials. However not everything is perfect on the sell side. So here are my unstructured thoughts.
1) Global vs local broker
I have two contrasting view on this. Having a Sell side analyst team might work better in large global brokers who have access to networks of experts, and who can hire specialised employees to cover every sector. It all becomes more difficult for smaller firms, who may not have the resources to hire industry pundits, unless they only want to focus on a few sectors. On the other hand, bulge bracket firms might be more interested in just maximising the number of issues they cover, while boutiques may be able to track trends much more efficiently, as they are not expected to cover every blue chip out there.
2) No skin in the game
The analyst is usually barred from owning the stock she recommends, for fear of conflict of interest. Were the analyst to own the stock, it would be in her interest for others to buy it, in order for the price to increase. However this also means that the analyst does not really care if the stock tanks. Her reputation with clients will suffer, however the “pain” will be limited.
3) Risks for investors are not clearly highlighted
It is spelled out in the name. The job of a sell side analyst is to sell the recommendation, which prompts analysts to overemphasise positive aspects of the stock they are recommending. In analysts’ reports, the “risks” page is usually very brief. However no stock is perfect, and it should be the job of an analyst to point out risks to clients. This however is contrary to the analyst’s incentives, as it is her job to direct trading to her broker. And if clients are informed of risks, they might decide not to buy the stock. Bye bye commissions!
4) Pressure to come up with new ideas, and reluctance to embrace those same ideas
Nobody is interested in hearing the same story for the 10th time. So it is the job of the analyst to come up with new interesting takes. However the recommendation might not be well received if the idea is perceived as being too novel, both on the employer side, because it might be too hard to sell, and on the client side, as they might be too conservative.
5) Positive bias
It is quite common for analysts to be labelled as bullish, given the fact that the majority of their recommendations are “BUY”s. I do not believe this is because analysts are more optimistic than other markets participants. I think this might be down to the fact that the analyst needs to interact with Investor Relation representatives, who might not be very forthcoming if the analyst has recommended shorting the stock.
6) Need for expert knowledge
To be a good analyst one would theoretically need to be an industry expert and to be very good at finance as well. That is not the case in many instances, leading to brokerage report that are, often, inaccurate.
7) Chinese walls
If a broker is also involved in IB activity, it does not pay to have its analyst slap a SELL label on the company. Of course, there are regulations in place to try to prevent conflict of interest, however one does wonder how effective these measures are. As anybody who has ever taken a close look to any broker reports can probably say, I am inclined to believe not very effective.
So where does this leave us?
Ultimately, in my opinion, it all boils down to this question:
Why be a Sell side analyst when you can be a Buy one?
Buy side analysts do not need to stress positives too much, are not getting paid via “indirect” revenues, have more freedom on where to focus their research efforts, do not have conflict of interest with their non-existing IB divisions, and, more importantly, they are working for themselves. Being a Buy side analyst makes more sense to me than being a Sell side. But I might be completely wrong, as I have not tried being on that side. At least, not yet.
Opinionated 