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The Value of Analysts in Stock Market Investing

21 July 2008 - Features - Editor

Analysts perform a vital role in the time-strapped investor’s decision making process. Conducting in-depth research on a company’s financial status is time-consuming, and many investors just don’t have the time available to do the job well. Analysts provide investors with the information they need as a basis for decisions on whether they should buy or sell certain securities.

Analyst ratings have become so popular that, instead of merely gauging a company’s viability as an investment, they actually influence the price of securities. A change in an analyst’s rating, no matter how slight, can have a profound effect on stock prices. It is the opinion of some in investing circles that analysts wield too much power, while others rush to their defense. Whether it is a good or bad thing remains debatable, but the fact is that analysts play an influential role in stock market investing and it is in an investor’s best interest to understand what various analysts base their recommendations on.

A sell-side analyst (also referred to as an Equity Research Analyst) evaluates companies for a range of investment criteria, including future earnings growth. These analysts work for a brokerage or a firm that manages individual accounts, making recommendations to their employer’s clients with regard to investments. The phrases “buy”, “sell” or “hold” are typical of sell-side analyst recommendations. The recommendations of a sell-side analyst are generally recognized as “blanket recommendations”, which means they are directed at all the clients, and not an individual. A blanket recommendation has drawbacks, in that each investor is an individual and a broad recommendation may be incompatible with an individual client’s investment goals. So, whilst taking note of sell-side analysts recommendations, investors should determine whether following that recommendation is in his/her best interests. Although one would not want to insinuate that sell-side analysts issue recommendations just to generate stock trading, it must be remembered that a brokerage gets a commission on all transactions – more transactions equals more commission.

A buy-side analyst’s recommendations are only available to the pension fund or mutual fund that employs him. These analysts determine the possible benefits of an investment in line with the fund’s investment strategy. The success of a buy-side analyst is gauged by the number of profitable recommendations made to the fund. If a fund employs a good analyst, it would not want competitors to have access to the same advice.

As the name would suggest, an independent analyst is not employed by anyone, but aims to offer unbiased and objective ratings. Independent analysts earn their living by carrying out fee-based research, which is where the companies they research pay them to do so. The main possible draw-back of fee-based research is the question of whether paid for ratings are truly objective. There have been a number of cases in the past where fee-based research has been used by unscrupulous firms to manipulate stock prices. Nevertheless, while these cases may still occur, following the guideline for fee-based research issued by the National Institute of Investor Relations (NIRI), this type of research is being increasingly recognized as a valuable tool by investors. Independent analysts also sell subscription-based reports.

 


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