Pollard Banknote Ltd T.PBL

Thoughts on sellside research...things to keep in mind....

[FormerHedgie]

I think it is very important to understand several things about sellside research.  I spent many years as an analyst, I was top ranked by Brendan Wood so I think I was able to add value to the institutional buyside before I was hired to the buyside and became a portfolio manager.

Here are some insights that I think are important to consider when consuming sellside research,

1. Most (not all) analysts are excessively conservative in their estimates.  The is a heavy influence of group think.  They look at what others are doing and stay within the bounds of other people's research.  This type of group think really damages the quality of the work and insights presented.  Generally, the estimates represent the least aggressive or even realistic outcome for a stock.

2. Analysts tend to slow to responding / incorporating changes. The impact of group think can also be hound here.  Typcially, analysts wait for changes to materialize before they incorporate them into their estimates.  Almost always, if you are trying to deeply understand a company, its markets, customers, competition, opportunties etc the signs of change materialize long before they materialize and are incorporated into estimates etc.  For me, this delay was always too long.  I didn't think being a "reporter" was what my role was supposed to be. 

I was/wanted to be an "analyst".  My role was to see changes early, make educated assumptions about their impact and make a call.  You need to handicap your ongoing success but the idea that markets are efficient is completely inaccurate, especially in small cap stocks.  The signs of growth, profitability and future share price appreciation are well telegraphed and highly predictable.  My experience is that most analysts are really reporters NOT analysts and you should know this and don't rely on them to make your decisions.

3. Analysts are subject to pressure from many sources that prevent them from doing their jobs. 
Being a sell-side analysts is a VERY hard job.  The mechanics of the job are straightforward, make an excel model, populate it, make conservative assumptions and pretty much, "tow the market line".  Most analysts are deatlh afraid of being wrong and that prevents them from making a real call on a stock.  This unfortunately makes most sellside research useless.  When this happens the analysts has really become a reporter or historian reporting on things that have already happened.  You cannot make money following reporters.  The market is future focused and valuations are based on the future, not the present.  Rerports only report on the present / past at best.

The hard part about being an analysts is dealing with the influences such as your sales desk (sales / trading).  Managing the investment bankers in your firm.  I know that there is supposed to be hard walls that exist between banking / research, the reality is that they optically are present but in reality the bankers presence is felt by the analyst. 

You also must manage your relationship with the company management.  For me, especially in small cap, this is the single most important thing an analysts should be doing.  Most analysts do not have deep and trusted relationships with their management teams.  Usually, someone else in the organization owns that relationship and the analyst is just servicing the company with written materials.  You need to determine which analysts has the best relationship with the management tream.  Almost always, they will have the best / most insightful research.

4. There are good analysts, who do real work and have great relationships, you need to find out if they exist for the companies you invest in. If they do exist, the analyst will always know a LOT more than what they have written down.  This is where institutional investors have a real advantage over retail investors.  

I guess in summary, I don't personally place a lot of value on sellside reasearch unless you can find that one or two analysts who really understand their role but more and more these days, finding those analysts is diffcult. At best, use the research that comes out as a barometer of what people are being told. This can give you a real edge over everyone else who are actually relying on analysts for their understanding of the stock.  Do you own research, have your own target price etc...

Sorry, that wasn't meant to be a rant.  Just sharing my experience with sellside research.