Buy Side Analysts vs. Sell Side Analysts: An Overview
Much has been said about the “Wall Street Analyst”, as if it were a standard job description. In fact, there are major differences between sell-side and buy-side analysts. It is true that both spend most of their day researching companies and industries in an effort to snag winners or losers. However, the functions are very different on many basic levels.
- When the system works as it should, buy-side and sell-side analysts are valuable.
- Smart Buyers focus on quickly discovering who they can trust in the sell-side community.
- Dedicated sell-side analysts can dive deeper than buy-side analysts and learn the ins and outs of the industry.
- Usually sell-side analysts work for brokerages, while buy-side analysts work for funds.
If you’ve ever watched a financial news show, you’ve likely heard the reporter refer to “analysts.” These analysts are usually sell-side analysts and are believed to provide an unbiased opinion based on proprietary research on a company’s securities.
Simply put, a sales-side research analyst’s job is to keep track of a list of companies, all typically operating in the same industry, and to provide regular research reports to the company’s clients. As part of this process, the analyst typically builds models for presenting companies’ financial results, as well as talking with customers, suppliers, competitors, and other sources with industry knowledge.
From the public’s point of view, the end result of an analyst’s work is a research report, a set of financial estimates, a price target, and a recommendation about the stock’s expected performance. The estimates derived from the models of several sell-side analysts can also be averaged together to arrive at a single prediction called the consensus estimate.
Buy-side analysts vs. sell-side analysts
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 go up, while the opposite happens if the company misses the estimate. However, this is not always the case.
Occasionally, sell-side analysts fail to revise their estimates, but their forecasts do change. Sometimes financial news refers to a “whispering number,” an estimate that differs from a consensus estimate. This whispered figure becomes the latest consensus prediction, although unwritten.
When an analyst “initiates” coverage of a company, he or she usually assigns a rating in the form of “buy,” “sell,” or “book.” This rating is a nod to the investment community, as it depicts how an analyst believes a stock’s price will move in a given time frame. The rating can sometimes be a reflection of expected stock movement rather than how the analyst feels about the company’s performance.
In practice, the job of the sell-side analyst is to persuade institutional accounts to direct their trading through the analyst’s firm’s trading desk, and the task is largely related to marketing. In order to receive trading returns, the buy side must view the analyst as providing valuable services. Clearly, information is valuable, and some analysts will constantly look for new information or proprietary angles in the industry. Since no one cares about the third iteration of the same story, there is a tremendous amount of pressure to be the first to approach the customer with new and different information.
Of course, this is not the only way to stand out with customers. 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 a lot like that of a high-priced travel agent.
Further complicating matters is the fact that companies often restrict access to management by those analysts who do not stick to their line, which puts analysts in the uncomfortable position of giving useful (and potentially negative) news and opinions to the street and maintaining cordial relations with the company’s management. Investment banking is a huge source of profit for banks, and if an analyst makes a negative recommendation, the investment banking side of the business could lose that client.
Analysts also strive to create networks of experts they can rely on for a constant stream of information; After all, it stands to reason that a deeper understanding of the market or product will allow for differentiated calls.
Much of this information is absorbed and analyzed — and never actually makes it to the public page — and cautious investors may not necessarily assume that the analyst’s printed word is how they really feel about the company. Rather, it’s in private conversations with the buy side (the conversations that occupy a lot of an analyst’s day) where the real reality is imagined.
Buy side analysts
In contrast to the position of the sell-side analyst, the job of the buy-side analyst is all about being right; Leveraging the box with high-profile ideas is critical, as is avoiding big mistakes. In fact, avoiding negativity is often an essential part of a buy-side analyst’s job, and many analysts proceed from the mindset of figuring out what can go wrong with an idea.
On a daily basis, jobs don’t look all that different. Buy-side analysts will read the news (although most are sell-side analysts than sell-side analysts), track information, build models, and start businesses to try and deepen their knowledge about them. Area of responsibility – focusing on providing the best stock recommendations.
Although larger organizations will allocate their analysts similarly to sell-side analysts, buy-side analysts, in general, have broader coverage responsibilities. It is not uncommon for funds to have analysts covering the technology sector or the industry sector, while most sell-side companies have many analysts covering specific industries within those sectors (such as software, semiconductors, etc.).
While many sell-side analysts try to spend a lot 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. This doesn’t mean that many buy-side analysts don’t do their own proprietary research (the best always do); It just means that there is a lot of value to a buy-side analyst in developing a roster of transition analysts in their space.
Buy-side firms do not usually pay or buy sell-side research directly, but they are often indirectly responsible for compensating a sell-side analyst. Usually a buy side company pays soft dollars to a sell side company, which is a roundabout way of paying for research. Soft dollars can be thought of as additional money paid when deals are made through sell-side firms.
Basically, the research of sell-side analysts directs the buy-side company to make deals through the trading department, which results in profits for the sell-side firm. Additionally, buy-side analysts often have a say in how trades are directed by their company, and this is often a key component of selling-side analyst compensation.
Although sell-side and buy-side analysts are tasked with monitoring and evaluating stocks, there are many differences between the two jobs.
On the compensation front, sell-side analysts often achieve more, but there is a wide range, and buy-side analysts on successful funds (especially hedge funds) can do much better. It can be said that business conditions are skewed in favor of buy-side analysts; Sell-side analysts are often on the road and often work longer hours, although buy-side analysis is a higher-pressure job.
As job descriptions might suggest, there are big differences in what these analysts actually pay. Realistically speaking, sale-side analysts are paid largely for information flow and access to management (and/or high-quality sources of information). Buy-side analyst compensation is more dependent on the quality of the recommendations the analyst makes and the overall success of the fund(s).
The two functions also differ in the role accuracy plays. Contrary to what many investors expect, good models and financial estimates have less weight for the role of a sell-side analyst but can be critical to a buy-side analyst. Likewise, price targets and buy/sell/hold calls are not as important as sell-side analysts might think. In fact, analysts can be below average when it comes to modeling or stock picking, but they still do everything just fine as long as they provide useful information.
On the other hand, a buy-side analyst can’t 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. Likewise, buy-side analysts typically have less restrictive rules about stock ownership, disclosure, and outside hiring, at least with respect to regulators (individual employers have different rules regarding these practices).