Some Truth about Broker Research
BROKER BIAS
Now it's not a criticism, it is an education – at the bottom of all broker research, in the disclaimers, the broker will tell you whether they have done corporate deals for the companies mentioned, in which case they are probably the broker to the company – either IPO’ing the company or raising capital for it in the recent past. Or hoping to. Corporate deals are the be-all and end-all of a broker's existence. Making you money by writing independent research is not their purpose (hilarious that you might have thought that). Most broker research is marketing material, not advice. Doing corporate deals with companies is a broker's main income. After all, the stock market exists for one purpose. To raise capital when the banks won't lend it to you. Otherwise, why list? And a lot of the research is there to support the price. Because brokers have a duty to support their corporate clients. Broker research will also tell you at the bottom whether the analyst holds the stock mentioned.
Bottom line, you need to read the small print at the bottom of a bit of research to see whether the broker has a relationship with a company. You need to know if you are reading objective analysis and a genuine research opinion, or whether you are reading ‘marketing material’. Its hard to tell most of the time.
ITS NO GOOD BEING RIGHT IF YOU'RE DEAD
There is an old motorcycle adage that goes, “It’s no good being in the right if you’re dead”. Stockbroker analysts take note. Here is a story that explains it.
The broking house I worked for in 1990 lost their number one rated media analyst. We were in the UK, and he had just written a brilliant piece of research on Maxwell Communications.
The research lifted the lid on one of the most powerful media moguls in the country and exposed the company for what it was. An opaque listed plaything with corporate governance standards that would curl the toes of the British “establishment” that invested in it. It was bust, and our man was pointing out that the King (Robert Maxwell) had no clothes.
It was all good, except for one unfortunate thing. Our man could not contain his own wit, something rarely encouraged in broking let alone broking research. He titled his note “Can’t Recommend A Purchase” (get it?).
Robert Maxwell rang up and insisted he be sacked. He was, even though he was right.
Of course, Robert Maxwell later fell off the back of his boat (or did he) and disappeared forever, leaving his sons to pick up the flak for a massive £440m misappropriation of funds from the company pension fund. It was an ignominious end for the Maxwells - one of the brothers left holding the can committed suicide, and you might recognise his daughter below.
The Maxwell Communications collapse vindicated our man. But he was not reinstated. Instead, he got picked up by another major broker and remained the number one rated media analyst, his salary even higher for the publicity over Maxwell.
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It seems being right is just not enough. There is an etiquette in research, unwritten rules that have to be respected, landmines that have to be avoided, and the truth is no defence.
WHY BROKERS DON'T SAY SELL
One of the biggest land mines for broker research is the “Sell” recommendation. There is a reason 80% of broker research says buy. In fact, there are a few reasons. Saying sell is one of the lowest return recommendations a broker can publish. Here’s why:
- Sell recommendations are more likely to be wrong than right because of the long term upward trend of the market. The price of any company that doesn’t go bust (a tiny minority) is almost certain to one day rise again. If you advise someone to sell something, especially a big stock, you are bound to look stupid eventually. Just leave it long enough. And as any broker can tell you, clients have tremendous powers of recall when it comes to money they didn’t make. They will remember and blame you decades later.
- The other blatant fact about sell recommendations from a business point of view is that the audience for a sell recommendation is limited to shareholders. It only appeals to a limited number of people. But the audience for a buy recommendation is the whole world. Which one do you think is going to generate more business.
- If you put out a sell recommendation, you have to ring people who have bought the stock and tell them they were wrong. It’s a hard sell, especially when they are one of the long term faithful. Not sure they’ll think you’re doing their share price any favours and woe betide you if you’re wrong. A good way for a broker to upset a few clients and do no business.
- One of the main ones, however, is this. Companies don’t like it when brokers suggest their painstakingly acquired shareholders sell. It is not good for relationships between the company and the broking house. A broker’s lifeblood is the relationships they build companies. The access to management is an edge. You can lose it all by upsetting the company with a sell recommendation. Why would a broker want to do that?
- Even if the analyst doesn’t care about the company relationship, writing sell is one sure way for the analyst to screw up the corporate relationship and the chances of his corporate department ever doing a deal for the company in question. Getting corporate deals is hard work, it can take years. Corporate departments are there to support companies and their share prices, not kill them. A sell recommendation from your own analyst is an Exocet missile for any corporate ambition.
- Finally, from the adviser’s point of view, no-one remembers when you save them from losing money. Only when you make them money. And even then they tend to believe it was their own good judgement. There’s less mileage in a sell recommendation when it comes to reputation, even if you do get it right
It is a fact of life. Brokers almost always recommend a purchase, at least on the front page.
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