Why ‘buy’ outnumbers ‘sell’

MUMBAI: “These analysts are a bunch of crooks and the worst type of crook is a crook that wears a suit and is interviewed on CNBC” says Mitch Zacks, in his book, Ahead of the Market. Having made that statement, the author explains in detail why he thinks the way he thinks.

Equity analysts working for stock brokerage firms are supposed to write research reports, which tell the customers of the brokerage firm which stocks to buy and sell. These reports usually carry a recommendation at the start, like buy, hold or sell. A buy recommendations means that as per the analyst’s view, investors should buy this particular stock. A sell recommendation means exactly the opposite i.e., the investors should sell the stock. A hold recommendation means the investors should neither buy nor sell the stocks they have already accumulated.

The recommendation is the most widely used piece of information in an analyst report. As Zacks points out “Not surprisingly, the recommendation is probably the most widely used piece of information contained in the analysts’ research report, simply because it is, at face value, easy to understand and appears to be straight forward.”
In the Indian context, as markets have soared, in the last few years, the number of buy recommendations have gone up. The question that springs up here is “Why do analysts at any point of time issue more buy recommendations than sell recommendations?”

There are multiple reasons for the same. The research reports that analysts write are distributed by the brokerage firm to institutional investors like mutual funds, insurance companies, foreign institutional investors and individual investors with the brokerage firm.

And any analyst worth his salt is bothered usually about the institutional investors and not individual investors. This is because the level of respect of an analyst commands among institutional investors essentially decides the amount of money he makes.

Further, analysts do not want to upset the institutional investors by issuing a sell recommendation. This is because a sell recommendation spreads like wild fire, with everybody wanting to sell out. This can lead to the value of investments of institutional investors dramatically falling. Hence, analysts put a stock on a hold recommendation, giving enough time to the institutional investors to get out and after that they may or may not issue a sell recommendation.

Institutional investors carry out their trades through a brokerage firm. This helps the brokerage firm earn money. As Zacks points out “A prestigious or prescient analyst would work hard to develop a following among portfolio managers and, in return, the portfolio managers would execute their trades at the brokerage firm where the analyst worked. The more respected the analyst, the more the analyst could make for the firm where he worked, and more money the analyst would be paid in bonuses.”
A sell recommendation does not go down well with the company on which it has been issued. The company can limit the access of the analyst issuing a sell recommendation to them. This can put the analyst at a huge informational disadvantage vis-a-vis other analysts in the market.

As Zacks points out “Hell hath no fury like a CEO who has lost several million dollars due to some smart-aleck analyst. You can bet that for the next several years - and perhaps for as long as that CEO is in power — that the aggrieved company is not going to do any business where the pessimistic analyst works (and it’s also possible that the analyst will fired). While most investors may forget about the sell recommendation in a couple of months, corporate management tends to have a much longer memory.
When you lose several million dollars worth of stock options — as the CEO of a downgraded firm will attest — you tend to take it very personally.”

The brokerage does not make money by writing reports. They make money by selling shares. As Zacks points out “A buy recommendation has more value to a brokerage firm because it gets the brokers on the phone selling stocks to new clients and opening new accounts.” Given this, it makes more sense to issue buy recommendations.

Brokers tend to use latest analyst recommendations to get investors to change their holdings i.e., sell the stocks they are holding and buy into new stocks. But this may not always be in the best interest of the investor.

As Zacks writes “One of the biggest and most correctible mistakes you can make using analyst recommendations is to allow the recommendations as a means by which brokers can sell you a stock. You may not fully realise that the more you trade, the more money your brokerage firm makes, and that your brokers personally pocket between 25-50% of the fees that you generate for the brokerage firm.”
source:-www.dnaindia.com