The case for BIAS
I have been reading websites on how to interpret analyst valuations and recommendations. From what I’ve read, there’s always a warning that the recommendations can be biased based on a number of reasons and investors should thoroughly read the disclosures, do their own research, etc. There are many reasons why the analyst could be biased or have “conflicts of interest”, I have listed out the ones that I found from the SEC (U.S. Securities and Exchange commission):
- Investment Banking Relationships—When companies issue new securities, they hire investment bankers for advice on structuring the deal and for help with the actual offering. Underwriting a company’s securities offerings and providing other investment banking services can bring in more money for firms than revenues from brokerage operations or research reports. Here’s what an investment banking relationship may mean:
- The analyst’s firm may be underwriting the offering—If so, the firm has a substantial interest—both financial and with respect to its reputation—in assuring that the offering is successful. Analysts are often an integral part of the investment banking team for initial public offerings—assisting with “due diligence” research into the company, participating in investor road shows, and helping to shape the deal. Upbeat research reports and positive recommendations published after the offering is completed may “support” new stock issued by a firm’s investment banking clients.
- Client companies prefer favorable research reports—Unfavorable analyst reports may hurt the firm’s efforts to nurture a lucrative, long-term investment banking relationship. An unfavorable report might alienate the firm’s client or a potential client and could cause a company to look elsewhere for future investment banking services.
- Positive reports attract new clients—Firms must compete with one another for investment banking business. Favorable analyst coverage of a company may induce that company to hire the firm to underwrite a securities offering. A company might be unlikely to hire an underwriter to sell its stock if the firm’s analyst has a negative view of the stock.
- Brokerage Commissions—Brokerage firms usually don’t charge for their research reports. But a positive-sounding analyst report can help firms make money indirectly by generating more purchases and sales of covered securities—which, in turn, result in additional brokerage commissions.
- Analyst Compensation—Brokerage firms’ compensation arrangements can put pressure on analysts to issue positive research reports and recommendations. For example, some firms link compensation and bonuses—directly or indirectly—to the number of investment banking deals the analyst lands or to the profitability of the firm’s investment banking division.
- Ownership Interests in the Company—An analyst, other employees, and the firm itself may own significant positions in the companies an analyst covers. Analysts may also participate in employee stock-purchase pools that invest in companies they cover. And in a growing trend called “venture investing,” an analyst’s firm or colleagues may acquire a stake in a start-up by obtaining discounted, pre-IPO shares. These practices allow an analyst, the firm he or she works for, or both to profit, directly or indirectly, from owning securities in companies the analyst covers.
The SEC is the primary overseer/regulator for U.S. securities markets. They’re supposed to protect investors! Please educate yourselves by reading the entire link that I’ve provided above.
Personally, I think this is a very tough job because people go above and beyond for money and some find questionable/illegal ways to do this at the expense of others. The stock market is zero-sum game, meaning that when someone gains $1,000, someone else will lose $1,000.