Do investors value sell-side analysis?

The value or otherwise of research by analysts working for financial institutions has long been a subject of sometimes-heated argument. Criticism has ranged from the flippant – “If they’re so good at forecasting, why aren’t they richer?” – to the rather more serious observation that initial forecasts tend to be revised again and again, often to move into line with other analysts’ or guided by management.

Then there is the fact that, traditionally, such analysts – those whose work is made available to clients and, in modified form, to the media –work for the “sell side”, those institutions such as banks and brokerages that distribute shares.

The “buy” side – fund managers, investment trusts and others – have generally kept their analyses entirely to themselves. This is unsurprising, given that there is little incentive for those buying rather than selling assets to share their good ideas with the outside world. But it has tended to heighten suspicion that the sell-side institutions could be using such analysis to talk up the value of their client-companies’ stocks or promote excessive trading at the expense of long-term investment.

Of course, anyone can snipe from the sidelines. Our purpose was to find out what value real investors, as opposed to the critics, place on sell-side research, gauging their attitude by their demand for it. We can say that our findings are positive for the analysts, in that demand for their work significantly trumps that for the company’s own financial-reporting information, both summarized financials, and the voluminous reports that companies are required to file with the US Securities and Exchange Commission (SEC) in the interests of investor protection.

We are far from the first to try to measure the value placed on sell-side research by investors. But technological constraints limited the ways in which our predecessors could do this. Frequently they employed one of two methods – either counting the number of analysts following a particular stock or measuring the response of the stock market to analysts’ reports.

We are fortunate that advances in technology have allowed us to observe demand for research more directly.

Analysing financial website traffic patterns

Yahoo Finance is the most popular website for financial information in the US, providing specific coverage of all stocks publicly listed on American exchanges. The sheer size of its usage on the Yahoo Finance site suggests that the traffic patterns are representative of US retail investors.

We focused on both estimates from analysts, which we defined as forecasts of earnings-per-share and sales; and their share ratings and target prices for stocks, which we describe as opinions. In scrutinising the Yahoo Finance page views, we looked at the different levels of demand for each of these categories separately, and we also examined the different market conditions in which investor demand for analysts’ work rose or fell.

A key finding is that the appetite for analyst information on Yahoo Finance is highest on days when the management of the company concerned is issuing guidance (such as a profit warning) or making earnings announcements – or when the firm feels obliged to make an unscheduled Form 8-K announcement, named after the requirement to inform the market of information or events that could be of importance to its shareholders or to the SEC. This indicates that individual investors look to analysts to see what they have to say about the credibility of management’s forecasts and the impact on firm value.

Surprisingly, the same is not true of days on which a firm files either a Form 10-Q (a relatively brief report on its performance that is required in each of the first three quarters of the financial year), or a Form 10-K (the annual year-end filing with audited financial statements).We also find little demand on days with a Form 4 filing, which details changes in shareholdings by either company insiders or large shareholders.

Let’s put some figures on these different levels of demand. Investor searches for analyst information are 181.8% higher than average on days when the company’s management issues guidance; they are 152.9% higher on days when the company makes an earnings announcement, and they are 5.9% higher on days involving a Form 8-K announcement.

More surprisingly still, the demand levels on days of Form 10-Q, Form 10-K and Form 4 filings are not merely average, but below average, to the tune of 9.4%, 10.6% and 2.4%.

There seems to be no escaping the conclusion that there is a severely limited retail-investor demand for financial statement information and company filings with the SEC. Here’s an illustration of this: on days when there is no financial information on a company, the demand for analyst information on Yahoo Finance is on average more than six times that of Yahoo Finance’s SEC filings pages and more than double that of its pages of financial statements.

Demand for forecasts depends on trading

The gap widens further on “financial event” days, to 20 times that of SEC filings and four times that of financial-statement pages.

As we mentioned earlier, the demand for analyst information significantly trumps that for financial reporting information. Retail investors, on average, clearly prefer to let analysts scrutinise and interpret financial reporting information rather than try to do the job themselves.

But not all analyst information is equal. Overall, the demand for estimates (forecasts of earnings per share and sales) is 19.9% lower than that for opinion (share ratings and target prices for stocks). Again this may be surprising, given that one may have thought that the at least superficially objective estimates would have more appeal than the clearly subjective opinion.

That said, this is an average figure and the patterns vary depending on the nature of the trading day. On earnings-announcement days, demand for estimates is 73.8% higher than for opinion and it is 30.8% higher on days when management guidance is announced.

But demand is lower on days involving events such as Form 8-K, Form 10-Q and Form 10-K.

One big factor behind investor demand for analyst information is the visibility of the company in question on the day in question. Media news flow is one aspect of this, with unexpected coverage causing investors to seek guidance and clarity from analysts.

Other high-visibility factors include changes in coverage by the analysts themselves – Yahoo Finance records a 9-15% increase in demand on such occasions.

Of course, analyst research is not directly available on Yahoo Finance, but appears in truncated form in attention-grabbing news reports, spurring further demand. Celebrity analysts can push up traffic by 68.2% on days when they issue reports. A piece from a bold analyst can lift demand by a more modest but still substantial 39.4% and a work of timely analysis can mean an 8.8% increase.

The fact that Yahoo Finance users are predominantly retail investors obviously limits our ability to read these results across to the professional-investment community. Limits, but does not prevent – for two reasons.