In his December 2004 paper, Michael Cliff examines the period 1994-2003 to answer the following question: “Do Independent Analysts Provide Superior Stock Recommendations?” For his investigation, “independent” means not involved in an investment banking relationship between one year before and two years after a recommendation. He finds that:
- Independent analysts are less likely to issue Strong Buy and Buy recommendations and more likely to issue Sell recommendations than are conflicted analysts. (See the chart below.)
- The Strong Buy and Buy recommendations of conflicted analysts significantly underperform the overall market, with higher volatility. The Strong Buy and Buy recommendations of independent analysts perform about the same as the overall market. Conflicted analysts were especially slow to downgrade, with the bear market exacerbating their underperformance.
- The Hold recommendations of conflicted analysts dramatically underperform the overall market, while the Hold recommendations of independent analysts slightly outperform the overall market.
- The Sell recommendations of conflicted analysts underperform the overall market to a degree that suggests shorting (although shorting would have drawn margin calls during the first half of the period examined). The Sell recommendations of independent analysts significantly outperform the overall market, surprisingly doing better than any other category.
- The banking relationship conflict of interest is the most likely reason that conflicted analyst Strong Buy, Buy and Hold recommendations underperform independent analyst recommendations.
- Many terminations of coverage plausibly result from a desire by conflicted analysts to limit damage to banking relationships.
- It is a mystery why anyone pays attention to analyst recommendations, whether conflicted or independent. “The few glimpses of positive performance are probably largely offset by transactions costs.”
In summary, if you consider analyst recommendations when picking stocks, you really should check for investment banking conflicts. Better yet, just ignore the analysts.
Could frontrunning of analyst recommendations by large clients of analyst firms could dampen post-publication returns or recommended stocks?
