City Analysts: What They Do and Whose Side They’re On

Every day, equity research notes land on the desks of fund managers across London. A single analyst upgrade can move a share price by several percent within minutes of the market opening. Understanding what analysts are, how they make their living, and whose interests they ultimately serve is one of the more practically useful things a private investor can learn.

Equity analysts work for investment banks, stockbroking firms, and independent research houses. Their job is to follow a group of companies within a particular sector, build financial models, and produce written research notes containing earnings forecasts and a price target. At the end of each note comes the recommendation: buy, hold, or sell. These notes are aimed primarily at institutional investors, pension funds, and hedge funds. Private investors rarely read the original research, but they feel its effects in share price movements, and they often encounter the summaries reproduced in the financial press without the context that surrounds them in the original document.

For most of the twentieth century and well into this one, equity research at investment banks was bundled together with trading commissions. If a fund manager wanted to buy or sell shares through a bank’s trading desk, part of what they paid for was access to the bank’s research. The analyst’s salary was effectively covered by the trading revenue the bank generated. This arrangement began to change with MiFID II, the European regulation that came into force in January 2018, which required investment managers to unbundle and pay for research separately. The rules reshaped the industry significantly. Many banks cut their analyst headcount, and independent research firms grew to fill some of the space left behind.

The conflict of interest at the heart of traditional sell-side research, the research produced by banks and brokers rather than by fund managers themselves, was never quite a secret. The same bank that employed an analyst to produce a buy recommendation on a company might also be advising that company on a share issue, a merger, or a debt refinancing. Recommending a company’s shares is considerably easier to justify internally when the bank has a profitable advisory relationship with that company. Recommending a sell is a much more awkward proposition. The sell-side analyst occupies an unusual position: formally independent, but employed by an institution with commercial relationships running in many directions across the same market they are supposed to be assessing objectively.

This tension was most visible during the dot-com boom, when Wall Street analysts issued enthusiastic research on internet companies that their banks were helping to float or advise. When the bubble collapsed, the gap between private research notes and public recommendations became a significant scandal in the United States, leading to regulatory action and substantial fines. The UK was not immune to similar pressures, though the regulatory response under what was then the FSA, and is now the Financial Conduct Authority, took a different form. MiFID II was designed partly to address the underlying structural conflict directly, by severing the financial link between research and trading commissions and making research a product that investors have to consciously choose and pay for.

Most private investors assume that when an analyst says sell, they mean the share is heading down. The reality is more complicated. The distribution of analyst recommendations has historically been heavily skewed towards buys. Studies of published research over long periods consistently show that sell or underperform recommendations account for a small minority of all calls, sometimes fewer than ten percent of the total. Part of this reflects commercial pressures. Analysts who cover a sector become known to the companies in it, and relationships matter to both sides. A sell recommendation on a company with which the bank has, or hopes to win, an advisory relationship is an awkward call to make. The result is a vocabulary of graduated caution: neutral, hold, underperform, sector laggard. Most investors would not recognise these as bearish signals without reading the small print carefully.

Earnings revisions are where analysts tend to be more genuinely useful to independent investors, precisely because they are less visible and less subject to the relationship pressures that shape outright buy or sell calls. When an analyst revises their earnings forecast for a company upwards, institutional investors pay close attention, particularly when several analysts covering the same stock move in the same direction within a short period. A cluster of earnings upgrades across a sector or a single stock can signal improving conditions before the share price has fully absorbed them. Private investors rarely have access to the underlying financial model, but the direction of travel in earnings estimates is tracked by financial data providers and carries real information for those who know to look for it.

The practical lesson is to treat analyst recommendations as one input among several rather than as instructions. When a broker note appears in a newspaper or on a financial website, a few straightforward questions are worth asking before acting on it. Which way are earnings estimates moving? Does the publishing bank have an advisory relationship with the company being covered? Is this a small, less-followed company where a fresh research initiation is bringing it to a wider institutional audience for the first time? And is the recommendation being reported in isolation, stripped of the qualifications and caveats that filled the body of the original note?

City analysts can be very good at their jobs, and a well-constructed research note, with its competitive analysis, channel checks, and earnings bridge, can be genuinely informative. But the analyst is working for a firm, that firm has commercial interests, and the buy or sell recommendation that sits at the top of the note is typically the part most shaped by those interests. The body of the note tends to be more honest than the headline. Learning to read both, and to understand the gap between them, is a skill worth developing.

This post is drawn from The Street-Smart Trader by Ian Lyall. Republished with permission.

Street Smart is a series drawn from first-hand experience of the City of London, updated as each new chapter arrives.

Nothing in this article is financial advice. Investment values can go up as well as down, and you may get back less than you invest. Always do your own research before making any investment decision.

This article is for informational purposes only and does not constitute financial advice. Investment values can go down as well as up. Always do your own research before making any financial decisions.