Sell-side analysts 'walking on eggshells'

Investors tend to underestimate the 'reputation management' pressure on equity research analysts when it comes to earnings forecasts and buy/sell calls, says Monash Investors.

Monash Investors principal Simon Shields spoke to InvestorDaily about what he calls the “recurring situations and behaviours that drive mispricing in Australian equities”.

Mr Shields, whose absolute-return-focused fund was set up in 2012, took particular issue with what he calls ‘analyst reputation management’.

“People underestimate the pressures that are on analysts: the risks that are involved in doing their jobs, and what that means in terms of the forecast that they give to the market,” he said.

“Broking analysts are basically walking on eggshells. They don’t want to upset their value managers versus their growth managers.”

Nor do sell-side analysts want to upset the brokerage desk of their firm by being too optimistic, he added.

“They might have a company that they think is absolutely wonderful. It’s got 60 per cent upside in earnings,” Mr Shields said.

But for the market to think the analyst is bullish on the stock, only a 30 per cent earnings forecast is necessary, he added.

“If it doesn’t pan out and [the stock doesn’t hit 60 per cent earnings growth] and only gets half of that, the market will still think the analyst is a whizz-kid,” Mr Shields said.

“So there’s a real herd mentality. You don’t want to get too far away from the pack, because if you’re wrong you get your head chopped off.

“Particularly if you’re wrong and you’re negative about a company. Then you can lose your job. So there’s a lot of pressure on these analysts,” Mr Shields said.