One of the great things about the role of equity research is that it provides the potential for objective analysis of companies. Analysts have a unique role in the markets. When done well (which is getting harder, analysts can cut through a lot of the noise in the market. They have the ability to provide honest opinions. We would argue that this is very important to markets, but it is one of those things that may have value but it is hard to get paid for doing.
In our previous posts we talked about the value ascribed to research by its clients, i.e. the Buy Side. We labeled this expertise as “Deep Focus”, or the way analysts get to know companies and industries so well that they can call out big mistakes or deviant behaviors.
However, there is another constituency that benefits from this – company management teams. For most exec teams, dealing with analysts is a bit of headache. Analysts require a lot of time. The role requires a healthy dose of self-confidence, which means management has to handle analysts with kid gloves, and do a little ego-stroking. But good analysts can provide real value. Modern management techniques tend to have an imperial bent to them, meaning that it is easy for CEOs to be surrounded by hive-minds always ready to agree with them. Having an outsider provide honest input can actually be incredibly useful, especially in the absence of other feedback loops. The best analysts (and, to be fair, bankers) we know are sought out by management teams. Less for their role as marketing mouthpieces and more as sounding boards. Good analysts can provide management teams with clear insight into what shareholders really want to see. Great analysts can provide management teams with true strategic insight and weighty competitive intelligence.
Of course, we are all familiar with the many potential conflicts of interest in the research model. Analysts can be too friendly to management, too friendly to their largest clients, too friendly to bankers, etc. That being said, analysts have a powerful incentive towards objectivity. They have public reputations, and the need to maintain those is a strong force. Analysts who are too friendly to management get dismissed by the Buy Side. Analysts who are too friendly to clients get shunned by companies. Analysts who are too friendly to bankers end up getting little for the effort and eventually end up under compliance searchlights. The best analysts find a way to balance all of those countervailing forces.
Unfortunately for the business, these glowing, ideal analysts we describe above is a relatively small group. The pressures of the business today make walking that tightrope a very tiring exercise. This burns out many. Which leads us back to our conclusion from the previous posts – there are too many analysts out there today, and the role is likely to shrink further. Nonetheless, we are heartened by the thought that there is still room for research analysts. Somewhere.