Tuesday, September 14, 2010

What Motivates Your Analyst?

The United States Court of Appeals for the Second Circuit once characterized the exchange of information between corporations and investment analysts as “a fencing match conducted on a tightrope”. If investor relations officers are going to be successful in such a treacherous environment, it helps to understand the analyst on the other side of the conversation and what motivates them. Different analysts have different approaches, and early on in this blog I wrote about “information vampires” (March 2007), “elephant hunters” (April 2007), and “channel checkers” (July 2007) as prime examples of the way some analysts approach things. Now comes a New York Times article published on September 12, 2010, entitled “The Loneliest Analyst” about Richard Bove, a banking analyst that offers some good insights about the way another type of analyst works.

The bulk of the article concerns the lawsuit brought by BankAtlantic, a Florida bank, against Bove for a report he issued about the banking industry in 2008, which ranked the bank’s holding company as among the most risky financial institutions based on financial ratios. The lawsuit was eventually settled without liability to Bove, but it left him the poorer by $800,000 in legal fees. While the drama surrounding the lawsuit is interesting to anyone who has ever listened to a CEO fume about what he thinks is unfair or inaccurate in an analyst’s report, the more interesting part of the article occurs when Bove speaks about his work.

The lead in the article talks about how Bove likes to take “extreme positions” which can occasionally move the markets, gaining him prestige and notoriety. It then cites as an example a recent opinion issued by Bove that government rules would curb mortgage profits and by implication, bank profits. When the share price of Wells Fargo, a large mortgage lender, begin to drop following the report, Mr. Bove’s phone lights up with calls and he states, “That’s what makes the game fun, right?”

According to the article, Bove’s work tends to focus on the big picture, because, as he puts it, “What’s the reason to pay me to be the 14th guy to tell you what is going to happen in the second quarter at Citigroup? There’s just no utility for a guy at a boutique that operates pretty much on his own to replicate the work of other analysts.”

So one of the takeaways from the article come from learning that analysts at boutique firms may have an entirely different motivation in how they approach research. Without the resources of some of the bigger shops, their focus may be on hitting the home run as opposed to maintenance research, or on big picture, macro stories. Understanding if the analyst you are speaking with takes a differentiated approach will help you as an investor relations officer have a more meaningful discussion with that analyst.

In another interesting portion of the article, Andy Kessler, a former Wall Street analyst, is quoted as saying that it’s common for analysts to change their opinion styles in order to cater to their clients: “If your clients are mostly hedge funds, you’re going to give mostly short-term analysis”. Given that a large percentage of trading volume these days comes from hedge funds, it’s no wonder that we get mostly short-term analysis.

So two quick takeaways from the article: understand what motivates the analyst, and know who his clients are will help you understand his research approach. Sounds a lot like the old broker rule of “Know your client”, but this time reversed.

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