This month:

Marcus Padley

The broking house I worked for in the UK in 1990 lost its number one rated media analyst. He had just written a brilliant piece of research on Maxwell Communications. The research lifted the lid on one of the country’s most powerful media moguls and exposed the company for what it was: an opaque listed plaything with corporate governance standards that would curl the toes of the British “establishment” that invested in it. It was bust, and our man was pointing at the king with no clothes.

It was all good, except for one unfortunate thing. Our man could not contain his own wit, something rarely encouraged in broking let alone broking research. He titled his note “Can’t Recommend A Purchase” (get it?). Robert Maxwell rang up and insisted the man be sacked. He was, even though he was right.

Maxwell later fell off the back of his boat and disappeared forever, leaving his sons to pick up the flak for a massive £440 million misappropriation of company pension funds. It was an ignominious end for the Maxwells and a development that vindicated our man. But he was not reinstated. Instead he got picked up by another major broker and remained the number one media analyst, on an even higher salary.

It seems being right is just not enough. There is an etiquette in research, unwritten rules that have to be respected, landmines that have to be avoided, and the truth is no defence. As the old motorcycle adage goes, “It’s no good being in the right if you’re dead”. Analysts take note.

One of the biggest landmines is the “sell” recommendation. There are a number of reasons why 80% of broker research says buy. Saying sell is one of the lowest-return recommendations a broker can publish.

For a start, sell recommendations are more likely to be wrong than right because of the long-term upward trend of the market. The price of any company that doesn’t go bust (a tiny minority) is almost certain to one day rise again. If you advise someone to sell, especially a big stock, you are bound to look stupid eventually. And as any broker can tell you, clients have tremendous powers of recall when it comes to money they didn’t make. They will remember and blame you decades later.

The other blatant fact from a business point of view is that the audience for a sell recommendation is limited to existing shareholders. It only appeals to a limited number of people. But the audience for a buy recommendation is the whole world. Which one do you think is going to generate more business?

If you put out a sell recommendation, you have to ring people who have bought the stock and tell them they were wrong. It’s a hard sell, especially when they are one of the long-term faithful. They’ll think you’re not doing the company’s share price any favours and woe betide if you’re wrong. It’s a good way for a broker to upset clients.

A lot of broker research is “marketing material” written in support of a fee-paying corporate client. You need to know if you are reading objective analysis and a genuine research opinion, or marketing material. It’s hard to tell most of the time. Read the small print to see whether the broker has a relationship with a company. It might explain why they like the company, because they raised capital for it and have a duty to play an investor relations role for it. And, of course, the higher the price, the more likely they are to raise capital again, and whoever supports the company the most gets the deal.

One of the main reasons, however, is that companies don’t like it when brokers suggest their painstakingly acquired shareholders sell. Analysts’ lifeblood is the relationships they build with their researched companies and the access they have to management. Why would they want to screw that up?

Even if the analyst doesn’t care, writing sell is one sure way to screw up the chances of their corporate department ever doing a deal for the company in question. Getting corporate deals is hard work; it can take years. Corporate departments are there to support companies and their share prices, not kill them. A sell recommendation from your own analyst is an Exocet missile for any corporate ambition.

Finally, from the adviser’s point of view, no one remembers when you save them from losing money - rather it’s only when you make them money. And even then they tend to believe it was their own good judgement. There’s less mileage in a sell recommendation when it comes to reputation, even if you do get it right.

It is a fact of life. Brokers almost always recommend a purchase, at least on the front page.