Stock research is more than just a headline

May 18th, 2009

Posted by: Eric Auchard

– Eric Auchard is a Reuters columnist. The opinions expressed are his own –

Stock research analysts get no respect these days. An academic study has concluded that share recommendations have little impact.

A 51-page study entitled “On the information role of stock recommendations,” finds that buy and sell ratings are uninformative and often try to “piggyback” on actual news for their influence. This begs the dismal question: if professional analysts can’t get it right, what hope for the ordinary investor?

Sell-side research — driven by the need of the analyst’s employer to trade stocks — dominates daily market conversations. Recommendations are the signposts of these debates, without which many investors would be lost.

Analysts are not alone in selling their independence to the highest bidder, and their reputation has suffered after so many were exposed as marketers for investment bankers, favoured clients or company managements. But independence is not the same as efficacy of stock recommendations.

Equities analysts are not unique in showing herd behaviour Oya Altinkilic of the University of Pittsburgh and Robert S. Hansen of Tulane University are correct to protest that stock ratings too often rely on past returns, and are poor indicators of future performance.

However, stock ratings are only a distillation of the analysts’ work. Their reports help investors make sense of announcements and prepare them for upcoming news. As with journalism, there is plenty of slip-shod analysis, or useless ratings changes made after the fact. Yet investors depend on analysts for a lot more than binary buy/sell ratings.

The methodology may explain the findings. The data measured the impact of ratings changes only for the 20 minutes before and after analysts published new recommendations.

The Pittsburgh/Tulane duo might instead have interviewed directors of those thousands of companies which are not covered by any analyst. Their stocks often have zombie status, with low ratings and no trade, because investors fear they will never be able to sell if they buy.

Analysis is not a road to riches from blindly following recommendations, but it oils the wheels of share trading, and the last year has shown what happens when liquidity dries up.

Rather than produce trite conclusions from some questionable research, the researchers might investigate why so many analysts are leaving the business under the pressure of compliance and regulation. Their loss makes markets poorer, whatever their recommendations

http://blogs.reuters.com/great-debate/tag/research-analysts/