895
n
Liaisons and intrigues
Analysts, astrologers, and lemmings – three of a
kind?
“Financial forecasting appears to be a science that makes
astrology respectable,” Burton Malkiel, Professor of Economics at
Princeton, once said.
As you know, analysts, employed by investment banks, follow a
number of rms (usually in a particular industry), evaluate them,
and offer us recommendations, in terms of buy, sell, or hold on
whether we should invest in their shares.
However, on average, these analysts give advice to sell in under
5 percent of cases. Yet, clearly, more than 5 percent of listed
companies’ share prices go down. So what’s going on?
Well, there are various explanations, but one is that, for various
reasons (pertaining to incentives in investment banks), analysts
are inclined to cover rms whose share price they expect to go
up. Therefore, perhaps an even more important decision than
whether to recommend buy, sell or hold is the decision of which
rms to cover.
And this is where it gets tricky (and almost a self-fullling
prophecy). Research has shown that the stock price of rms goes
up when they gain analyst coverage. That is,
purely the fact that a research department
(employing the analyst) decides to start
covering the rm will increase its share
price, probably simply because the rm
becomes more well-known, is exposed to
additional investors, which enables it to
raise capital more easily, and so forth.
But how do research departments decide to start covering a rm?
Well, research by Professors Huggy Rao, Henrich Greve, and Jerry
Davis showed that this is very much inuenced by imitation.
They analyzed 1,442 rms listed on the NASDAQ stock market
and the analysts covering them and, through elaborate statis-
tical analysis, showed strong evidence that when one analyst
‘‘
Research has
shown that the stock
price of firms goes
up when they gain
analyst coverage.
’’
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