Excellent description of the analyst cycle:
Click Here To Read: Stock Analysts: Experts on Whose Behalf?
Introduction/Abstract (Via Brian Bruce Journal Of Behavioral Finance)
Q: Why didn’t Wall Street realize that Enron was a fraud?
A: Because Wall Street relies on stock analysts. These are people who do research on companies
and then, no matter what they find, even if the company has burned to the ground, enthusiastically
recommend that investors buy the stock.
—Dave Barry, Humor Columnist
Investors rely on the opinions of experts to help us pick stocks. Whether one buys stocks through a 401(k) plan, or manage the mutual fund for individuals investing in the 401(k) the decision maker utilizes expert opinion. Those experts are supposed to be stock analysts. Recent scandals like Enron have caused these analysts to be much maligned. We will examine the role of those analysts, their motivations and the amount of useful information they provide.
The Analyst Cycle (Via Brian Bruce Journal of Behavioral Finance)
To understand analyst recommendations, one must first understand the analyst cycle. This cycle is a description of all the forces that act on analysts in their making a recommendation. The first part is the source of much information to an analyst: company management. Company management provides financial projections about future earnings and provides access to the analyst to members of company management to discuss the firm’s prospects. In this part of the relationship, the analyst is a non-paying client of the company.
There is a second part to the relationship between company and analyst. Many analysts work for firms that are investment banks. Investment banks solicit companies for business such as issuing bonds or additional stock for the company. The relationship now may be that the company is the client to the analyst and his firm. Since the analyst works for the firm, he must not get in the way of the investment banking marketing effort and, in fact, may be asked to help in that effort.
The next relationship is that of the analyst to the investor. The analyst provides the investor with information about a security. In return, the analyst needs the investor to trade with the analyst’s firmin order for his firm to generate revenues. Many times in a portfolio manager’s career, he receives a call from an analyst asking if the portfoliomanagervalues the information that the analyst sends. If the portfolio manager answers yes, the analyst will generally ask for a certain level of trading commissions to flow to his firm. Many analysts are judged based on the amount of trading flow they bring into a firm.
Finally, there is the link back to the company. The investor will act on the information provided by the analyst (along with other information). This will affect the price, which is of great concern to company management. As stock options became more prevalent in the 1990’s the concern of senior management turned from earning a large cash bonus to getting lots of stock options and maximizing their value. This causes senior management of a company to be very concerned about what investors think about the company.
Click Here To Read: Stock Analysts: Experts on Whose Behalf?
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