Something good from Wall Street – sell-side research is better

Analysts on the sell–side do a better job than buy-side analysts. A recent article in the summer 2008 issue of the Financial Analysts Journal finds that buy-side analysts are more optimistic than their sell-side brothers and sisters and generally do a poorer job then the sell-side, “Buy-side vs. Sell-side Analysts’ Earnings Forecasts” by Boris Groysberg, Paul Healy and Crag Chapman. Interesting! The sell-side is supposed to be in the bag with investment banks so there supposed to be overly optimistic about the stocks of clients which the banks have an economic interest in courting. The numbers prove otherwise with the sell-side being more accurate and less optimistic. Look at their earnings estimates and targets and not on the recommendations.

The researchers find that the pressure cooker of Wall Street forces analysts to do a better job. The best and worst on Wall Street are more likely to change jobs. The best move up the letter for better compensation and the worst are forced out of the business. The kinder and gentler buy-side is less willing to eliminate poor performers and may not be willing to pay for top analysts or those analysts get promoted to portfolio management jobs. The economic competitive story makes sense even if more decisions are made by portfolio managers. Now the sample is not for all buy-side analysts but this is an interesting counter-factual result from what may be expected.

A downsizing of Wall Street may actually create more market inefficiencies for those who are left standing. There will be less competitive research done on the street because there will be less analysts and less places for good analysis to move to. The buy–side will be more dependent on their research which may not be as good. There will also be less collaboration or competition between buy and sell-side analysts to provide the best ideas to the client, portfolio managers. Investors still need good research.