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INTERPRETING ANALYST RECOMMENDATIONS

Market Analyst

Market analysts monitor the securities of publicly traded companies to make trade recommendations to investors. Analysts exert a great deal of influence on stock prices due to their extensive reach throughout global media channels. Recommendations they provide include buy, strong buy, near-term, over-perform, under-perform, neutral and hold. Researching the background of analysts is crucial prior to investing personal capital as they often have conflicting interests which can skew the advice they offer.

There are various types of analysts:

Sell-side analysts

Primarily work for brokerage firms and offer recommendations for the securities they cover. These brokerage firms also usually provide investment banking services for corporate clients whose securities they cover.

Buy-side analysts

Work for financial institutions such as mutual funds, hedge funds and investment advisers that buy securities for their own accounts. They provide counseling services regarding which securities to buy, hold or sell and reap profits when they’re on-target.

Independent analysts

Typically provide reports on a paid or subscription service and are not associated with firms that underwrite the securities they provide.

When looking into investment opportunities, always research the prospectus for public companies and the annual reports filed with regulatory authorities instead of only focusing on analyst recommendations. Companies will often hire investment bankers for advice on issuing and structuring new securities. Brokerage firms can reap greater profits when they underwrite a company’s securities and provide other banking services than when they only provide research reports or brokerage services.

Analysts working for such firms may write positive research reports for the company’s initial public offering (IPO) and support new stock issued by its investment banking clients. Such clients are specifically looking for positive reviews and if they are not provided, then they will look elsewhere for investment banking services. What’s more, upbeat analyst coverage of a company may attract other companies to hire the firm to underwrite a securities offering.

Brokerage firms usually do not charge for research reports; however, positive reports on stocks may drive more investments which creates increased commissions and bonuses. Another factor to consider is analyst ownership of covered company stocks. For instance, in venture investing, an analyst’s firm or employees can acquire a stake in a start-up through discounted pre-IPO shares. This enables the analyst and firm alike to profit by owning securities in a company they cover.

Before investing, look into whether the analyst’s firm underwrote a recommended company’s stock. You can verify this by referring to the prospectus, which is part of the registration statement for the offering. The list of the primary underwriters can be found on the front cover of the preliminary and final prospectus. You can figure out if an analyst or brokerage firm owns one percent or more of equity securities in a company by referring to the company’s registration statement and its annual report on Form 10-K.

While analysts can provide valuable insights into companies, it’s paramount to stay apprised of any potential conflicts of interest as those discussed above. Many factors can affect the independence and objectivity of certain analysts and drive your profit potential down.