15. Buy-Side vs. Sell-Side Analysts: What’s the Difference?¶
15.1. Buy-Side vs. Sell-Side Analysts: An Overview¶
Much has been made of the “Wall Street analyst,” as though it were a uniform job description. In reality, there are significant differences between sell-side and buy-side analysts. True, both spend much of their day researching companies and industries in an effort to handicap the winners or losers. On many fundamental levels, however, the jobs are quite different.
When the system functions as it should, both buy-side and sell-side analysts are valuable. Smart buy-siders make a point of quickly figuring out who they can trust and rely on in the sell-side community. Dedicated sell-side analysts can typically dive deeper than buy-side analysts and really learn the ins and outs of an industry. Sell-side analysts typically work for brokerages, buy-side analysts work for funds.
15.2. Sell-Side Analysts¶
If you have ever watched a financial news program, you have probably heard the reporter reference “analysts.” These analysts are typically sell-side analysts and are believed to provide an unbiased opinion based on proprietary research on a company’s securities.
Simply put, the job of a sell-side research analyst is to follow a list of companies, all typically in the same industry, and provide regular research reports to the firm’s clients. As part of that process, the analyst will typically build models to project the firms’ financial results, as well as speak with customers, suppliers, competitors, and other sources with knowledge of the industry.
From the public’s standpoint, the ultimate outcome of the analyst’s work is a research report, a set of financial estimates, a price target, and a recommendation as to the stock’s expected performance. The estimates derived from the models of several sell-side analysts also can be averaged together to come up with a single expectation called the consensus estimate.
Stocks may move, in the short term, based on an analyst upgrade or downgrade or based on whether they beat-or-miss expectations during earnings season. Typically, if a company beats the consensus estimate, its stock price will rise, while the opposite occurs if a company misses the estimate. However, this is not always the case.
Occasionally, sell-side analysts fail to revise their estimates, but their expectations do change. Sometimes financial news will refer to a “whisper number,” which is an estimate that is different from the consensus estimate. This whisper number becomes the newest, although unwritten, consensus expectation.
When an analyst “initiates” coverage on a company, he or she usually assigns a rating in the form of “buy,” “sell,” or “hold.” This rating is a signal to the investment community, portraying how the analyst believes the stock price will move in a given time frame. The rating can sometimes be a reflection of the expected stock movement and not a reflection of how the analyst feels the company will perform.
In practice, the job of a sell-side analyst is to convince institutional accounts to direct their trading through the trading desk of the analyst’s firm, and the job is very much about marketing. In order to capture trading revenue, the analyst must be seen by the buy-side as providing valuable services. Information is clearly valuable, and some analysts will constantly hunt for new information or proprietary angles on the industry. Since nobody cares about the third iteration of the same story, there is a tremendous amount of pressure to be the first to the client with new and different information.
Of course, that is not the only way to stand out with clients. Institutional investors value one-on-one meetings with company management and will reward those analysts who arrange those meetings. On a very cynical level, there are times when the job of a sell-side analyst is much like that of a high-priced travel agent.
Complicating matters is the fact that companies will often restrict access to management by those analysts who do not toe their line, placing analysts in the uncomfortable position of giving the Street useful news and opinions (which may be negative) and maintaining cordial relations with company management. Investment banking is a huge source of profit for the banks, and if an analyst makes a negative recommendation, the investment banking side of the business may lose that client.
Analysts also seek to create expert networks they can rely upon for a constant stream of information; after all, it stands to reason that a deeper understanding of a market or product will allow for differentiated calls.
Much of this information is digested and analyzed—it never actually reaches the public page—and cautious investors might not necessarily assume that an analyst’s printed word is their real feeling for a company. Rather, it is in the private conversations with the buy-side (conversations that occupy much of an analyst’s day) where the real truth is imagined to come out.
15.3. Buy-Side Analysts¶
In contrast to the sell-side analyst position, the job of a buy-side analyst is much more about being right; benefiting the fund with high-alpha ideas is crucial, as is avoiding major mistakes. In point of fact, avoiding the negative is often a key part of the buy-side analyst’s job, and many analysts pursue their job from the mindset of figuring out what can go wrong with an idea.
On a day-to-day basis, the jobs do not look all that different. Buy-side analysts will read news (though more of it is from sell-side analysts than the sell-side analyst would read), track down information, build models, and otherwise go about the business of trying to deepen their knowledge on their area of responsibility—all with an eye toward making the best stock recommendations.
Though the largest institutions will have their analysts allocated similarly to sell-side analysis, buy-side analysts, in general, have broader coverage responsibilities. It is not uncommon for funds to have analysts covering the technology sector or industrials sector, whereas most sell-side firms would have several analysts covering particular industries within those sectors (like software, semiconductors, etc.).
Whereas many sell-side analysts try to spend much of their time finding the best sources of information about their sector, many buy-side analysts spend that time trying to sort out the most useful sell-side analysts. That is not to say that many buy-side analysts do not do their own proprietary research (the good ones always do); it just means there is significant value to a buy-side analyst in developing a list of the go-to analysts in their space.
Buy-side firms do not usually pay for or buy the sell-side research outright, but they are often indirectly responsible for a sell-side analyst’s compensation. Usually, the buy-side firm pays soft dollars to the sell-side firm, which is a roundabout way of paying for the research. Soft dollars can be thought of as extra money paid when trades are made through the sell-side firms.
In essence, the sell-side analysts’ research directs the buy-side firm to make trades through their trading department, creating profit for the sell-side firm. Additionally, buy-side analysts often have some say in how trades are directed by their firm, and that is quite often a key component of sell-side analyst compensation.
Key Differences Key Differences ————————————
Although both sell-side and buy-side analysts are charged with following and assessing stocks, there are many differences between the two jobs.
On the compensation front, sell-side analysts often make more, but there is a wide range, and buy-side analysts at successful funds (particularly hedge funds) can do much better. Working conditions arguably tilt in the favor of buy-side analysts; sell-side analysts are frequently on the road and often work longer hours, though buy-side analysis is arguably a higher pressure job.
As the job descriptions might suggest, there are significant differences in what these analysts are really paid to do. Speaking realistically, sell-side analysts are paid largely for information flow and to access the management (and/or high-quality information sources). Compensation for buy-side analysts is much more dependent upon the quality of recommendations the analyst makes and the overall success of the fund(s).
The two jobs also differ in the role accuracy plays. Contrary to what many investors expect, good models and financial estimates have less weight to the role of a sell-side analyst but can be critical for the buy-side analyst. Likewise, price targets and buy/sell/hold calls are not nearly as important to sell-side analysts as some financial media might seem to think. In fact, analysts can be below average when it comes to modeling or stock picks but still do all right so long as they provide useful information.
On the other hand, a buy-side analyst usually cannot afford to be wrong often, or at least not to a degree that significantly affects the fund’s relative performance.
Buy-side and sell-side analysts also have to abide by different rules and standards. Sell-side analysts have to pass several regulatory exams that buy-side analysts do not. Likewise, buy-side analysts typically enjoy less restrictive rules on share ownership, disclosures and outside employment, at least insofar as regulators are concerned (individual employers have different rules concerning these practices).