Value of Analyst Research Is in Investor Recognition

New coverage of a stock by a brokerage firm analyst has only a limited effect on increasing the amount of information available and no measurable effect on the company’s performance.

The value of having a sell-side (brokerage firm) analyst initiate coverage on a stock is simply greater investor recognition. New coverage has only a limited effect on increasing the amount of information available and no measurable effect on the company’s performance.

Researchers looked at over 55,000 instances where a sell-side analyst began covering a stock during the period from 1996 through 2012. They sought to determine whether new coverage improved fundamental performance of a company (as measured by the change in return on assets, or ROA), the symmetry of information reflected in the bid-ask spread (the difference in price between what buyers bid and sellers ask) and the institutional ownership (a proxy for investor recognition).

One theory about the benefits of new coverage is that sell-side analysts will uncover areas of weakness and encourage the company’s executives to make necessary changes to improve the business. This, in turn, should lead to better profitability. The study does not find any link between the initiation of coverage and improved profitability.

Additionally, analysts fail to introduce enough previously uncovered information to the investors to have a meaningful impact. Though there is a small improvement in the bid-ask spread in the days following the initiation of coverage, the improvement disappears within two to three years.

Where analysts do have an impact is in terms of investor recognition. A positive return of 0.82% in the five days surrounding the initiation of new coverage was found. The positive impact on the stock’s price remained measurable over the following two- and three-year periods.

The researchers observed a few additional characteristics about the increased recognition. There is a notable increase in the proportion of institutional investors reporting ownership of the specific stock in regulatory filings. Coverage by analysts denoted as All-American Analysts by Institutional Investor magazine results in higher returns. The number of searches on the Securities and Exchange Commission’s EDGAR database for newly covered stocks also increases. On the other hand, when coverage ends because the brokerage firm closes or is merged with another firm, the returns of these stocks decline relative to the market.

Source: “What is the value of sell-side analysts? Evidence from coverage initiations,” by Kevin K. Li and Haifeng You, SSRN, August 31, 2015.