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Dependence-free Research

Failings of sell-side research

Stockbrokers’ lifeblood is commission income and market share. They make their money by encouraging clients to keep turning over their portfolios, a process assisted by providing research coverage and trading ideas.

It is perhaps unheard of for a sell-side provider to produce research – as A-List does - only on companies of a certain quality. The tendency is quite the opposite – to voice an opinion on the widest possible range of actively traded companies, so as to maximise potential commission income. For the investor, this can mean being inundated with a volume of ‘me too’ results commentaries and other superficial maintenance research reports. Sell-side salesmen may assist in filtering out research that is relevant, but only where the client generates sufficient commission income to justify the broker’s attention.

Brokers’ research is likely to spend no more than a paragraph describing the business, enough perhaps to give a salesman a sound bite for convincing the client that he knows the company. But the bulk of the research may focus on earnings estimates for the next year or two and a buy or sell argument that hinges on the price earnings ratio of one company being out of line with that of another similar company, or of the market.

By focusing on short-term valuation anomalies rather than business quality, brokers’ research can miss out on the big picture and can potentially deprive clients of the best long-term returns.

Elsewhere on the sell-side, research produced by a nominated advisor or company broker can serve primarily to raise the company’s profile with investors. And research from corporate finance houses can lend crucial support to a transaction which will generate fee income. Investors cannot reasonably expect objectivity here. You have to question for whose benefit the research is being provided – the intermediary or you, the investor.

By extension, where a company is small, its shares are inactively traded or it is not involved in corporate finance activity, the sell-side may have no incentive to provide research coverage at all. This often leads to a total absence of research coverage for some very good companies.