My Time on the Sell Side

“Wall street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway.” – Warren Buffett

My first experience in the investment industry was during my senior year of college. I spent an entire semester working for a group of sell side analysts.

This is the job that entails following a group of companies in a specific industry and issuing buy, sell and hold signals on each stock (or now it’s market outperform, strong buy, market perform – they change all the time). Along with these recommendations, analysts set price targets and put out earnings estimates and revenue projections.

For the uninitiated, these are the analysts that make the upgrades and downgrades you hear about all the time on financial television.

I learned a lot from this experience, but much of it didn’t sink in for a few years until I really started to understand how the finance industry works. Here are some of my realizations from my time spent on the sell side:

It’s All Relative.  The research analysts I worked with were all extremely intelligent. They knew the companies they covered inside and out. No part of the business structure was spared its rightful analysis. Everything was dissected and restated to try to capture the true nature of the company’s operating performance.

But spending so much time focusing on any one industry or sector can blind you to what’s going on in the rest of the market. Most analysts spend more time looking for great companies as opposed to great stock prices. There’s a big difference between the two. Also, many times the companies get compared to the rest of the industry, not the entire investable universe. There wasn’t much consideration of the possibility that a particular company was being priced as the best house in a bad neighborhood.

Garbage In-Garbage Out.  Financial models are fairly useless if you take them at face value. I dealt with extremely complex Excel spreadsheet models on a daily basis. They were a thing of beauty for spreadsheet geeks. Complex formulas and macros, linked data, pro-forma financial statements — all with the analysis spit out in a neat summary page. Every tiny piece of company and industry data was meticulously estimated or tracked down to the nearest decimal point.

Many of the analysts I worked with told me it was their modelling skills that really set them apart from their peers.  But what I found from navigating these models is that there was always one or two levers you could pull that would completely change your output (price target or earnings estimate). A minor change to a discount rate or future growth rate assumption could drastically change the end result by a wide margin.

I now know that these types of models are only good for setting ranges based on weighted probabilities. They’re made for ballpark accuracy, not precision and even if you understand this take them with a grain of salt.

Price Targets are Worthless.  Every couple of weeks the entire group of analysts from every industry in the department would get together for meetings to discuss the collective stock recommendations for the firm. There were probably 10-15 analysts that each covered 10-15 companies. So we’re talking hundreds of stocks in total. Yet when the head of research pulled up the total number of buy and sell recommendations from every analyst during one meeting, there were only 3 sell calls — in the entire firm. He was basically begging these analysts to make a sell recommendation or two. Yet they weren’t really budging because…

Relationships Matter. What I came to realize is that all of the number crunching didn’t matter nearly as much as the meetings and conference calls with company management. The head analysts were constantly on the road meeting with the management team along with suppliers, competitors, going trade shows, etc. These relationships all carried much more weight than the financial models that the junior analysts toiled away at back at the office. The analysts didn’t seem to want to make a critical call against a company in fear of upsetting the management relationship where they got their questions answered.

Independence is Key.  Not all analysts are compromised or bad people. It’s just the nature of the industry. It’s a difficult balancing act to put out reports on companies that could have other financing arrangements or consulting relationships with these banks and brokerages.  Also, there was really no mention of the clients when crafting the research reports.  It was only buy, sell or hold, not risk, patience or time horizon.

I’ve learned that independence in relation to process, relationships, incentive structures and analysis are all extremely important, especially in the finance industry where conflicts abound.

I do think some investors can utilize analyst reports for certain general informational purposes. It’s just that the quarterly earnings guessing game, review mirror changes in recommendations and price targets are not the answer. The long-term industry dynamics and extensive company information can help you spot trends in the business climate. But it’s nearly impossible to use any of this information for actionable long-term investing. And good luck trying to trade on the information as the short-term reactions never go quite as expected.

I’m a believer in taking lessons from all career opportunities, both good and bad. Sometimes negative knowledge by learning what not to do is just as important as figuring out the right way to do something.

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