Analyst Relations (#79)
/In this podcast episode, we discuss how analysts operate and how to deal with them. Key points made are noted below.
What the Analyst Does
The analyst investigates a public company, and creates an analysis of where he thinks the company’s stock price will go. He normally adds a buy, sell, or hold recommendation to the analysis, and then issues it to his client list. The clients are paying for this advice, so they want to see some good insights into each company being reviewed. If there isn’t, then they stop paying for the analyst. Alternatively, the analyst may work for a brokerage firm, in which case the brokerage will probably dump the analyst if there’s a string of bad calls. So, the analyst is on the hot seat. This is not a easy job, because it requires a great deal of industry specialization, and excellent contacts within that chosen industry, and good analysis skills on top of that.
Why a Company Needs Coverage
So why does a company need analyst coverage? Several reasons. First, if a well-known analyst chooses to cover you, then that’s a mark of prestige for the company. Also, an analyst can bring a large following of investors, which provides more liquidity for the company’s stock. And finally, an experienced analyst has lots of contacts, and can direct company management to people who can help them raise funds or place large blocks of stock. So, it makes a great deal of sense from a company’s perspective to have a strong analyst following.
The Lack of Analysts
The problem is that there aren’t so many analysts around any more. Whenever there’s a market downturn, large brokerage houses reduce the number of analysts that they keep on staff. Also, an independent analyst can’t survive very well in a down market, because clients won’t pay his fees when all stock prices are heading downhill. For these reasons, the analyst population declined over the past decade, and I don’t see it increasing any time soon.
So, how does this impact a public company? Well, the main impact has been on small and micro cap companies, which have lost all kinds of analyst coverage.
The reason is that a lot of analysts work for large brokerage firms, and each analyst recommendation has to generate the largest possible commission volume for the brokerage house in order to justify the cost of the analyst. So, if an analyst spends a lot of time creating a great research report on a company with almost no trading volume, then it’s a wasted effort.
How to Obtain Analyst Coverage
This doesn’t mean that it’s impossible for a small cap firm to obtain analyst coverage. But they need to avoid the larger brokerage firms and target small boutique brokerages and independent analysts, who have a lower cost structure, or perhaps who specialize in the company’s industry.
Your best bet for finding an analyst is to see who is covering competing companies that have a similar market cap. That type of analyst has already invested a lot of time in learning your industry, so they don’t need to put in a lot of work to provide coverage for your company, too.
How to Maintain Good Analyst Relations
So, what about the care and feeding of an analyst? If an analyst agrees to provide coverage, then what do you do? First of all, if you’re not providing guidance, then start doing so, because the analyst needs some foundation information from which to build his recommendations. If you’re comfortable with it, then also provide investor conference calls, so the analyst can ask more clarification questions.
Second, and this is critical, always provide conservative guidance. If you issue some really high-end earnings estimates and then can’t make the numbers, the analyst has probably already issued a buy recommendation based on your guidance, and now looks like a fool. Analysts really don’t like that.
Third, they like to meet directly with management, which is acceptable. However, you cannot reveal any material information to an analyst that you haven’t already issued to the investing public. To make sure that you don’t, it makes sense to have the investor relations officer sit in on these meetings and make note of any “indiscretions,” so that the company can file an 8K report to the SEC right away.
So, if you can’t reveal anything new to an analyst, why is a management meeting still important? Well, the analyst can legitimately pick up a great deal of information from a company visit.
This can include figuring out if the parking lot is full, if there’s too much inventory in stock, and even just getting a feel for how competent the management team appears to be. On top of that, it’s quite all right to discuss your view of the industry as a whole, and other competitors, and general operating conditions, which allows the analyst to build a piecemeal view of the company and its environment. This is called the mosaic approach to building a recommendation.
One thing that a good analyst will absolutely pick up on is any weakness in a manager’s knowledge about the company or industry, so make sure that you have a pre-determined answer to the standard questions, like who are the main competitors, and their strengths and weaknesses, and what is the market size, and market growth rate. One item that analysts love to address is the various risks that the company is subject to, so know what they are, and be prepared to talk about how the company deals with them.
Also, any time you update the corporate fact sheet, or fact book, or issue a press release or an 8K, always send them a copy. This gives them the best and most up-to-date information, and they really appreciate it.
After the analyst has completed an investigation of the company, he may send an advance draft of his analysis and recommendation to the company. I think it’s a good idea to note any incorrect information in the report, so that errors don’t start circulating through the investment community. However, there’s a risk that the company could be seen to have participated in writing the entire report, so it helps to keep the original and corrected versions, so the company can prove in court that it did not write the report. And under no circumstances should you comment on the analyst’s conclusions or recommendation, because that implies that you are taking ownership of the report.
If an analyst report turns out to be highly favorable, do not under any circumstances publish it on the company web site. The reason is that it gives the appearance of endorsing the report. Also, what happens if the same analyst then issues a negative report? Would you post that, too? Of course not. Instead, just list on the web site the name and contact information for the analyst.
Also, don’t expect too much from an analyst.
A “strong buy” recommendation only lasts as long as the company’s stock price is below the analyst’s target price. At some point, the analyst may very well post a “sell” recommendation, though most of the time they waffle with terms like “moderate buy” or “long-term buy” in order not to piss off management. They realize that those management meetings can be cut off at any time, so the standard drill is to simply back off their strongest buy recommendations. If they do this, it’s OK. Eventually, the stock price will drop to the point where they can issue a “Strong Buy” recommendation again.