Sell side research

What Is Sell side research?

Sell side research refers to the analysis and reports produced by analysts at financial institutions that sell investment products and services, such as investment banks, brokerage firms, and independent research houses. This type of financial analysis is primarily designed to inform and influence clients—ranging from large institutional investors to individual retail investors—about various investment opportunities and market trends. Sell side research falls under the broader category of financial analysis and plays a crucial role in the functioning of capital markets. The goal of sell side research is often to generate trading activity and commissions for the firm producing the research, providing clients with insights that can aid their investment decisions.

##²³ History and Origin

The landscape of sell side research has evolved significantly, particularly in response to conflicts of interest that became prominent during the dot-com bubble of the late 1990s and early 2000s. During this period, allegations arose that research analysts were issuing overly optimistic stock recommendations to secure investment banking business, rather than providing objective analysis. This led to a significant regulatory crackdown.

A pivotal moment was the Global Analyst Research Settlement reached on April 28, 2003, between the U.S. Securities and Exchange Commission (SEC), FINRA (formerly NASD), the New York Stock Exchange (NYSE), and ten of the largest U.S. investment firms. This agreement aimed to address and sever the perceived links between research and investment banking departments within these firms. It ²²introduced strict rules, including prohibiting analysts from receiving compensation tied to investment banking activities and barring their involvement in investment banking pitches and roadshows. Fur²¹thermore, it mandated that firms furnish independent research to ensure investors had access to objective advice.

Su²⁰bsequent regulations, such as FINRA Rule 2241 (effective in 2015), reinforced these principles by establishing comprehensive policies and procedures for managing conflicts of interest related to equity research reports and public appearances by research analysts. The¹⁹se rules emphasize the separation of research from investment banking supervision, budget determinations, and analyst compensation, aiming to foster greater objectivity and transparency.

##¹⁸ Key Takeaways

• Sell side research is produced by financial institutions like investment banks and brokerage firms to guide external clients.
• Its primary goal is to generate trading activity and commissions through actionable stock recommendations and market analysis.
• Sell side research analysts conduct in-depth equity research, building financial models and assessing company fundamentals.
• Regulatory reforms, such as the Global Analyst Research Settlement and FINRA Rule 2241, were implemented to mitigate conflicts of interest.
• While influential, sell side research can be subject to biases, and investors should consider it as one input among many for their investment decisions.

Interpreting Sell side research

Sell side research provides investors with a detailed examination of publicly traded companies, industries, and economic trends. Analysts typically assess a company's financial performance, competitive position, growth prospects, and often include a valuation and an investment thesis. The output usually culminates in a recommendation—such as "buy," "hold," or "sell"—along with a price target.

Invest¹⁷ors interpret sell side research as a source of information and an indicator of market sentiment. These reports can help validate investment ideas, identify trading opportunities, and provide a framework for understanding specific companies or sectors. For example, a hedge fund might use these reports to shortlist stocks for further due diligence. While s¹⁶ell side research aims to be objective, its inherent connection to generating trading revenue means that users must critically evaluate the content, considering potential biases that might influence the recommendations.

Hypothetical Example

Consider "Horizon Tech," a hypothetical software company, that is covered by analysts at a major investment bank, "Global Securities." A Global Securities sell side analyst, Sarah Chen, publishes a research report on Horizon Tech.

Sarah's report would typically include:

• Company Overview: A summary of Horizon Tech's business model, products, and market position.
• Financial Analysis: A deep dive into Horizon Tech's financial statements, historical performance, and key metrics. This often involves constructing elaborate financial models to project future earnings and cash flows.
• Industry Outlook: An assessment of the broader software industry, competitive landscape, and relevant macroeconomic factors.
• Valuation: Sarah would perform a valuation analysis, perhaps using discounted cash flow (DCF) or comparable company analysis, to arrive at a target price for Horizon Tech's stock.
• Recommendation: Based on her analysis, Sarah provides a "Buy" rating on Horizon Tech, with a 12-month price target of $150, implying a significant upside from its current trading price of $120.

A portfolio manager at a large mutual fund, a client of Global Securities, receives this sell side research report. They review Sarah's detailed analysis, including her assumptions and methodologies. While they conduct their own internal analysis, Sarah's report provides an additional, external perspective, which they might use to initiate or increase a position in Horizon Tech's stock, contributing to potential trading volume for Global Securities.

Practical Applications

Sell side research is integral to the functioning of financial markets and serves various practical applications. It provides detailed analysis that informs investment decisions for a wide range of market participants.

• Information Dissemination: Sell side analysts perform in-depth equity research on specific companies and industries, aggregating vast amounts of information—from company fundamentals and management insights to industry trends and macroeconomic factors. This cons¹⁵olidated information is then distributed through research reports, offering critical insights to investors.
• Facilitating Trading: By providing stock recommendations and price targets, sell side research aims to influence market sentiment and drive trading activity. This directly supports the sales and trading operations of brokerage firms, which generate revenue through commissions.
• Sup¹⁴porting Investment Banking and Underwriting: While regulatory firewalls are in place, sell side research still indirectly supports investment banking by offering coverage on companies that may be clients or potential clients for services like underwriting initial public offerings (IPOs) or advising on mergers and acquisitions.
• Pri¹³ce Discovery: Sell side analysts contribute to the process of price discovery in the market by issuing recommendations and forecasts that can narrow bid-ask spreads and the gap between buyers and sellers, thus helping to determine fair market value.

Limit¹²ations and Criticisms

Despite its utility, sell side research faces several limitations and has been subject to various criticisms. A primary concern revolves around potential conflicts of interest, particularly the historical ties between research departments and investment banking divisions. While regulatory actions like the Global Settlement and FINRA Rule 2241 have aimed to create a separation, the inherent business model of sell side firms can still create incentives that may compromise objectivity.

Studies ¹⁰, ¹¹have indicated that sell side analysts may exhibit biases in their recommendations. For instance, affiliated analysts (those whose firms have an investment banking relationship with the covered company) have been found to be more optimistic, slower to downgrade, and faster to upgrade stocks compared to their unaffiliated counterparts. This opti⁸, ⁹mistic bias can lead to a predominance of "buy" or "hold" ratings, making "sell" recommendations relatively rare.

Furtherm⁷ore, the pressure to generate trading volume and revenue can influence the focus and timeliness of sell side research. Analysts might prioritize coverage of companies that are actively traded or are potential corporate finance clients, potentially leading to less comprehensive coverage of other viable investment opportunities. The short-term focus driven by trading cycles can also differ from the longer-term perspective often adopted by investors focused on fundamental value.

The quality and independence of sell side research are continuous points of discussion within the financial community, prompting investors to conduct their own due diligence and diversify their information sources.

Sell side research vs. Buy side research

Sell side research and buy side research represent two distinct but interconnected functions within the financial markets, differentiated primarily by their objectives, audience, and the entities they serve.

Sell side research is generated by firms that create and sell financial products and services, such as investment banks and brokerage firms. Its main purpose is to serve external clients, including individual investors and institutional investors. The research reports often come with stock recommendations (e.g., buy, hold, sell) and price targets, with the underlying goal of generating trading activity, commissions, and supporting other firm-wide activities like underwriting or mergers and acquisitions. Sell side analysts typically specialize in specific industries or sectors and their research is generally publicly accessible or distributed widely to clients.

In contr⁶ast, buy side research is produced by firms that manage money on behalf of clients, such as mutual funds, hedge funds, pension funds, and asset management companies. The primary objective of buy side research is to support internal investment decisions and optimize the firm's own portfolio returns. Buy side analysts conduct proprietary, in-depth analysis that is typically confidential and tailored to their firm's specific investment strategies and long-term goals. While buy side analysts may utilize sell side research as an input, their ultimate recommendations are designed exclusively for internal use to maximize the performance of managed assets.

FAQs

What is the main purpose of sell side research?

The main purpose of sell side research is to provide financial analysis, insights, and stock recommendations to external clients of brokerage firms and investment banks. This research aims to inform client investment decisions and generate trading activity, which in turn contributes to the firm's commission revenue.

How ⁵does sell side research differ from independent research?

Sell side research is typically produced by firms that also engage in other activities like trading or investment banking, which can introduce potential conflicts of interest. Independent research, on the other hand, is conducted by firms that do not have such affiliations, aiming to provide unbiased analysis without the incentive to generate trading commissions or investment banking deals. Following regulatory settlements, some sell side firms are even mandated to offer access to independent research to their clients.

Is s⁴ell side research always objective?

While regulations like FINRA Rule 2241 strive to enhance the objectivity of sell side research by separating research from investment banking and prohibiting certain conflicted behaviors, some inherent biases can still exist. Analysts ³may have incentives to maintain positive relationships with covered companies or to generate trading volume, which can sometimes influence their recommendations. Investors should consider sell side research as one valuable input among many and conduct their own due diligence.

Who uses sell side research?

A wide range of market participants utilize sell side research. This includes large institutional investors like hedge funds and mutual funds, who use it to validate their own strategies and identify opportunities. Individua²l retail investors also rely on these reports for guidance. Additionally, corporate executives may review these reports to understand how analysts perceive their company's financial health and market position.¹