Investor's Deep Dive
Investment Insights You've Never Heard
Investor's Deep Dive
Analyst Stock Picks: Whoa Nelly!
In this episode, IDd takes a closer look at stock ratings and whether they genuinely reflect an analyst's opinion or if they’re influenced by outside pressures.
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All right, so we're tackling a pretty intriguing question today.
What really makes those Wall Street analysts tick?
The ones everyone watches to see if a stock is going to go up or down.
Exactly. Those analysts, the ones who stock picks everyone obsesses over.
We're going deep into the research on cell side analysts
to try to figure out what's really driving their buy cell or hold recommendations.
Yeah, and we've all seen tons of research on analysts
how accurate their forecasts are, all that.
But this research is different.
Totally different.
This is about understanding what's going on in their heads.
It's like peeking behind the curtain, you know?
Yeah, behind the curtain of Wall Street.
Right. And they actually went straight to the source surveyed
and interviewed hundreds of these analysts.
Wow, hundreds.
Yeah, hundreds.
And let me tell you, some of the things they found will definitely surprise you.
Like we always hear about those private calls analysts have with CEOs and CFOs, right?
Right. Everyone knows those happen.
But the crazy thing is how often they're happening.
Like it blew me away.
Really? How often are we talking?
Over half of the analysts surveyed talk to a CEO or CFO,
at least five times a year for each company they cover.
Five times a year.
So they're talking to these executives almost every month for each company.
And this is after RedJFD, right?
When companies have to be super careful about selective disclosure.
Right. Exactly.
So how are these conversations even happening so often?
Are they like finding loopholes?
Seems like it.
One analyst even mentioned that some companies are bringing in and get this FBI profilers.
FBI profilers?
What? To coach their executives on how to handle these calls with analysts.
Apparently they want to make sure they're saying enough to keep the analysts happy,
but not enough to get in trouble with regulators.
Wow, bringing in the FBI, that's intense.
Talk about high stakes.
Seriously, it makes you think twice about how much those public earnings calls really matter
if they're having all these private chats.
Right. It makes you wonder.
And it kind of highlights something else the research found.
How important client relationships are in an analyst's world.
How so?
Analysts said over and over that client demand is the biggest thing that determines what
companies they choose to cover.
So does that mean that they're more likely to cover a company that investors are already
interested in?
Yeah, basically, even if it's not the most innovative or exciting business out there.
So those hidden gems, the companies that haven't become popular yet.
They might be at a luck.
It makes sense if you think about it from the analyst's perspective.
They're providing a service and their clients, the big institutional investors,
they want the inside scoop on companies they're already invested in or thinking about
investing in.
I guess that explains why some companies get way more attention than others.
Exactly.
And speaking of things that carry a lot of weight, let's talk about broker votes.
You mean those trading commissions that institutional investors control?
Exactly.
The study found that those broker votes actually have a bigger impact on an analyst career
than winning some prestigious industry ranking.
Really?
So it's more important for their careers than even something like winning an institutional
investor award.
It seems that way.
Why is that?
Because at the end of the day, it all comes down to money.
Ah, of course.
Broker votes equal revenue for the firms.
One analyst even said, and I'm paraphrasing here, success in this business isn't about
how accurate your stock picks are.
It's about how good your broker votes are.
Wow.
Yeah.
It's kind of a blunt way to put it.
But it makes you realize how much pressure these analysts are under to keep those big clients
happy and those trading commissions coming in.
For sure.
So it sounds like those earnings forecasts as important as everyone thinks they are.
They're just one piece of a much bigger puzzle.
That seems to be the case.
The means to an end.
Right.
Research found that the main reason analysts are so focused on getting their earnings forecasts
right is so they can make accurate stock recommendations.
They need to make calls that resonate with the people who control the money.
Right.
It's not just about crunching numbers.
So with all this pressure to keep everyone happy, are we ever getting their unbiased opinions?
Right.
How often are they being told to change their recommendations to please a big client or
she?
Because their firm is doing a deal with that company.
That's what everyone wants to know.
It's the million dollar question.
How much influence do these outside forces really have?
And what did the research find?
You might be surprised.
Well, the research found that it's not as common as you might think.
Really?
Yeah.
It seems like it happens less than you might expect.
Interesting.
Okay.
So tell me more about this pressure from above.
Who's feeling the heat the most?
Well, younger analysts, the ones who are newer to the game, they were more likely to say
they felt pressure to change their recommendations.
And here's the thing, analysts at banks with big investment banking arms, the ones making
those mega deals, they were also more likely to report feeling pressure.
Ah, so they have to be careful not to upset the apple cart.
Right.
Exactly.
Yeah.
You don't want to bite the hand that feeds you, especially when that hand is holding
millions of dollars in potential investment banking fees.
Yeah, talk about a conflict of interest.
Exactly.
It reminds you that there's a lot going on behind the scenes at these big firms.
But here's another interesting finding when it comes to sneaking out those bad actors.
You know, the company's trying to mislead investors.
Right.
Most analysts don't really see it as their job to catch them.
Wait, really?
You think that would be part of their job, right?
Making sure the numbers add up, uncovering any accounting shenanigans?
You think so.
But most analysts assume that the financial statements they're given, the audited ones,
at least are accurate.
Interesting.
They're not really digging for dirt, which I guess is kind of reassuring.
It is reassuring, but also a little bit concerning, right?
Yeah.
I mean, we've all heard those stories about companies cooking the books.
Right.
Exactly.
And that's a really important takeaway for anyone who's following the markets.
We can't just assume that analysts are going to catch everything.
We have to be informed and understand the pressures they face.
Right.
We can't just blindly trust those buy and sell recommendations.
Exactly.
It's crucial to do your own homework.
Be your own financial detective.
Okay.
So we've talked about the pressure they're under.
But what about the work itself?
How do those earnings, forecasts, and stock recommendations actually come together?
Is it all algorithms and spreadsheets or what?
Well, spreadsheets are definitely involved.
I bet.
But it's not quite as simple as just plugging in numbers and letting a computer do all
the work.
Yeah.
Analysts really emphasize the importance of industry knowledge.
Oh, interesting.
So it's not just about the numbers.
No, not at all.
Really understanding a specific sector that consistently ranked as the most valuable factor
in their analysis.
With for making those earnings forecasts and for coming up with stock recommendations.
So you have to understand how the whole industry works, how the companies compete with each
other.
Right.
You have to understand the big picture.
And that's actually where those private conversations with management come in.
Oh, right.
Those frequent chats with the CEOs and CFOs.
Yeah, exactly.
The ones with the FBI profilers.
Right.
Well, those calls, they were consistently ranked as one of the most valuable sources of information
for analysts.
Yeah.
And more valuable than those public earnings calls or investor conferences.
Wow.
So you're telling me that a five minute phone call with a CEO can give you more insight
than hours of presentations and Q&A.
That's what the analyst said.
They said those one-on-one conversations, let them go beyond the scripted presentations
and ask more nuanced questions.
Ah, okay.
So it's about getting a better feel for what management is really thinking.
Right.
These words like color and granularity to describe it.
I see.
So it's not about getting spoon fed specific numbers.
It's about understanding the context, reading between the lines, getting a feel for the company's
overall direction.
Exactly.
And that's where that deep industry knowledge becomes so valuable.
They can use those private conversations to pressure test their own assumptions, see
if they're understanding of the industry aligns with what they're hearing for management.
It's like piecing together a puzzle.
Right.
But instead of a picture, you're trying to see the future of a company.
Exactly.
Fascinating.
Okay.
So what about the actual tools of the trade?
Did they mention any specific methods or models they used to actually make these predictions?
Sure.
So, financial models, they're definitely a cornerstone of their work.
I bet.
But you might be surprised to learn that they're not always that complex.
A lot of them rely heavily on those tried and true methods like price to earnings ratios
and discounted cash flow analysis.
Really?
I would've thought they'd be using all kinds of super complicated wire street algorithms.
It seems like simplicity still has a place even on Wall Street.
Interesting.
I guess if you can't explain it simply, it's not that useful.
Exactly.
They need to be able to explain their reasoning to clients in a way that makes sense.
That makes sense.
Wow.
We've covered a lot of ground here.
From the surprising power of those broker votes to the importance of those behind closed
doors conversations with CEOs, it's been pretty eye opening.
Yeah.
It's because you that there are real people behind all those numbers and predictions.
But speaking of real people and their potential to, well, bend the rules a bit, let's talk
more about those red flags.
Oh, right.
You were saying that most analysts don't see themselves as fraud detectives?
Exactly.
So, this study actually took it a step further and asked analysts about specific warning
signs.
Things that might make them question whether a company's numbers are on the up and
up.
Okay.
Like, what kind of red flags give me the juicy details?
Well, they asked about things like weak corporate governance.
Right.
So, like, is the company being run responsibly?
Exactly.
Or a sudden surge in those one-time items on a company's balance sheet, you know?
Those can sometimes be a little fishy.
Yeah.
Those are always a bit suspicious.
Right.
Or even if a company reports material weaknesses in its internal controls over financial
reporting.
Basically, anything that makes you go, hmm, are you sure those numbers tell the whole
story?
Absolutely.
So, the question is, did seeing these red flags actually change how analysts viewed the
companies they cover?
I'm curious to know.
Did it make them more skeptical?
Well, you might be surprised to hear this, but a lot of those classic red flags didn't
really phase them.
Really?
Yeah.
They mostly said that they trust the audited financial statements they're given.
Interesting.
So, they're giving companies the benefit of the doubt?
It seems that way.
They're not necessarily assuming there's some malicious intent, which I guess, you know,
it's good to be optimistic.
Right.
It does make you wonder.
Yeah.
I mean, we've all heard those stories about companies pushing the limits, right?
Bending the rules until they break.
Exactly.
And that's why it's so important for anyone who's following the markets.
We can't just be passive observers.
We have to understand the pressures these analysts are under and look beyond just the headlines.
Right.
We have to think critically about everything.
Exactly.
Do your own research, dig into those financial statements, you know, maybe even channel
your interactive a little bit.
Love it.
You know, they have all the answers when it comes to the market.
Right.
They seem like wizards sometimes.
Right.
But the truth is a lot more complicated than that.
They're insights are valuable, for sure.
But it's so important to remember that they're operating within a system that has its
own rules and incentives and its own blind spots too.
Exactly.
So to our listeners out there, don't be afraid to ask tough questions, challenge assumptions,
and most importantly, do your own homework.
The more informed you are, the better you'll be able to navigate the markets and reach
your financial goals.
I couldn't have said it better myself.
It's been a pleasure diving deep with you today.
Until next time, keep asking those insightful questions and remember, knowledge is power.