Taking Stock / Return of the Analysts

They're baaaaack. After a two-year hiatus, the Wall Street analysts are reconquering the business pages and Web sites. Their tone has changed, they are more cautious and they're sporting new categories for shares. But make no mistake: They're still using exactly the same business model.

A popular joke has it that there are two types of investors, the ones with short memories and the ones with no memories at all. Both would do well to remember just who these analysts are, whose recommendations the press obediently publishes by the gross.

Who are they? Sell-side analysts, not buy-side analysts. Sell-side analysts work at investment banks, mainly for the people selling the shares - the companies, their leaders and their main shareholders. Who do the recommendations by sell-side analysts target? Mainly the buy-side analysts who work for asset management companies, such as provident funds, mutuals, pension funds and insurance companies.

Sell-side analysts and buy-side analysts are two entirely different animals, employing utterly different business models. Sell-side analysts make their living from two types of commissions. One is when the investment bank that employs them handles a stock offering, or merger deal, for a company the analysts cover. The other is commissions on trade in the covered company.

Sell-side analysts are valued according to the commissions they make for their employer bank. Buy-side analysts are measured by the investment decisions they make, by the return on shares they choose to buy or sell. The reports in the papers are on analyses by sell-side analysts, who would sell their grannies for space in the press; it's part of their job. Buy-side analysts work behind the scenes. They don't want people to know what they're up to.

l Primarily a marketer. His job is to market the shares of the companies he covers. If he fails, there will be no trade in the share through him, and his company won't get fat fees from issues and advising on mergers and acquisitions.

l But he can't confine himself to marketing; he also has to bring added value to institutional investors, to his friends on the other side of the wall, the buy-side analysts. So he has to bring them new information and ideas, to persuade them to employ his services. If he doesn't have the best and freshest information to offer, the buy-side analysts will seek it elsewhere and he'll lose his fees.

l Much of his time is devoted to compiling forecasts of the profits the companies will present in the quarters to come, because that's what investors expect of him. On Wall Street, stocks shares dance to the tune of earnings per share.

l No sell-side analyst can predict a company's earnings per share without the help of the covered company's management, preferably the CEO and CFO. So sell-side analysts have to cuddle up to the managements, weaving ties that bind.

l To foster warm relations with management leading to "tips" about earnings in the quarters to come, the analyst often has to "pay." He does that by disseminating superlatives and playing that silly game of "beating the forecasts" - he issues a profit-per-share projection that the company can exceed, by a few cents per share. And when a company "beats" the forecast in a bull market, there is "justification" for its share price to rise. In the last couple of years, the CEOs and money managers were leery of tipping off the analysts, so instead they issued general guidelines that turned into a "consensus" of most of the industry.

l Managements flood analysts with information when business is booming. So in bull markets, analysts look like geniuses: They evince a remarkable intimacy with the subject matter, and their forecasts pan out to the letter. But when the tide turns, the management will betray even the most sympathetic of analysts, leaving them stunned, bereft of information and mad as hell.

l From time to time, analysts go to war with managements. That might seem to contravene their own best interests. But it is generally a sign that the analysts have zero chance of getting any deals from the company, as it's already working with some other investment bank. This is a golden opportunity for an analyst to clad himself in unbiased professionalism.

l In a bull market, analysts can make a mint. The stars will earn millions a year. High-rankers will make $500,000 to $1 million. Even novices can score $100,000 or more. They have intense conflicts of interest and spend much of their day wriggling madly, stuck between the rock (make more money for institutional investors) and the hard place (make more commissions for their investment bank).

They hate the conflicts of interest that characterize their work just as much as their customers do. One of the few happy moments is getting that envelope with the annual bonus inside. What they really want is to retire at 40 with their millions in hand and say, thank the Lord I'm not an analyst any more.