What Does a Sell-Side Analyst Rating Mean?

Sell-side analysts work for institutions (such as an investment bank or brokerage firm) that receive money from investors. The job of a sell-side analyst is to track the performance of various securities, (most frequently equities like stocks), for certain companies and use their research models to project a company’s future financials. Some of the research they provide comes from the company itself and some of it comes from their own fundamental and technical analysis. The sell-side analyst’s work culminates during earnings season when they provide an equity research report that includes a recommendation and stock price targets. Since different firm will hire their own sell-side analysts, it is not uncommon for a stock to have a dozen or more analysts’ recommendations. When all the analyst ratings are released, the recommendation that is most common is known as the consensus estimate.

Although a sell-side analyst’s recommendation is available to the public and usually issued to the financial media within minutes of being released, the primary job of the sell-side analyst is to present investment recommendations to their clients based on their research of the companies they are following. This is done in an effort for the analyst to bring money into the firm that they work for. In almost all cases, this research is given to the client at no cost.

The client of a sell-side analyst is a buy-side analyst. These analysts work for the institutions that have skin in the game. They may work directly for an asset manager at an investment institution such as a mutual fund company and have positions (i.e. be invested) in the stocks that they analyze.

The sell-side analyst conducts equity research to come up with a recommendation. Along with a rating such as “Buy”, “Hold”, or “Sell”, an analyst’s recommendation comes with price targets. The basic ratings of an analyst are as follows:

• Strong Buy or Buy Recommendations: This means that the analyst is making a recommendation for investors to buy a particular stock or security.
• Strong Sell or Sell Recommendations: This means that the analyst is making a recommendation for investors to sell or liquidate their position in a particular stock or security
• Neutral or Hold Recommendations: This means they are not calling for the investor to take a specific buy or sell action; rather they are giving their opinion on the performance of the stock. Typically this rating is given when an analyst expects the stock to perform in a way that is consistent with the performance of the broader market, or with comparable companies within the analyst’s sector of expertise.

In recent years, many analysts have started to add clarify the expected movement of their stock forecasts using two additional categories:

• Underperform Rating: This means the expectation for the stock is that it will perform below the market or sector average. To add further nuance, words like "moderate sell”,“ weak hold", or “underweight” may be used in the place of “underperform”.
• Outperform Rating: This is the opposite of an “underperform” rating. Stocks that receive this rating are expected to outperform the market or sector average. Other words like “moderate buy”, “accumulate”, or “overweight” may be substituted depending on the analyst.

Investors should be careful to take each analyst report at face value since not all ratings mean the same thing. A “hold” from one analyst may be more bearish than a “sell” from another analyst who may be pointing out a short-term technical challenge for a stock that they feel has a long-term bullish outlook.

Since a stock price is affected by corporate earnings, the job of an analyst is estimating what earnings they think will be reported. In a perfect world, companies would provide complete transparency and analysts would be able to make a recommendation with a high degree of confidence. In the real world, companies have an obligation to their shareholders to put their company in the best possible light. And while the Securities & Exchange Commission (SEC) has strict rules that act as a deterrent from companies outright manipulating their filing documents, the information they provide is limited and in some cases provided without much context.

The analyst needs to create this context. They do this by using their own computer models, valuation calculations, and factoring in current economic conditions. They will also take into account generally accepted accounting principles (GARP) when reviewing a company’s balance sheet to see if their revenue and profit met expectations. The balance sheet can also provide clues regarding how much debt a company is carrying. Sell-side analysts will also listen to the conference call (or earnings call) to get clarity on their own findings and to listen for unexpected surprises or disappointments. 

And after all that, a sell-side analyst’s recommendation is only one of many.  Every firm employs its own sell-side analysts because they are typically dedicated to a particular sector, and possible to only a few companies within that sector. Many equity analysts may provide stock recommendations on the same stocks for years. Over time, this can make their recommendations carry more weight for the buy side analyst. However, the buy side analyst will always conduct their own proprietary research that will be in addition to research provided by the sell-side analyst. Unlike a sell-side analyst’s research report, the equity analysis of a buy-side analyst is not available to the public.

One of the criticisms leveled against sell-side analysts is that the nature of their jobs presents a conflict of interest. Many of these analysts develop close relationships with executives in the companies that they issue reports on. There is a concern, therefore, that they could allow a favorable opinion about a person in a leadership position to interfere with their objective view of the stock. Investors should pay attention to the disclaimers of every earnings report for details on how the analyst is compensated. This can help explain any bias an analyst may present when issuing a particular rating.

This has been less of a concern since the tech bubble crash of the early 2000s due to increased regulation from the Federal Government that requires analysts to use commonly accepted valuation methods in their analysis. However, this movement towards regulation is creating growing concerns among buy-side analysts about the availability of significant research, particularly regarding small companies. This is particularly true in Europe where the EU recently issued the Markets in Financial Instruments Directive (MiFID II) which unbundles research and transaction costs. This measure prohibits the common practice of using “soft dollars” (which can be monetary or non-monetary) as an incentive for one party to trade with another. It also means that EU investment managers can only receive research from sell-side analysts if they pay for it. Not surprisingly, this is leading to a lack of research, particularly on smaller companies, a shrinking pool of sell-side analysts, and a tendency for some research to contain more “speculative hype” to set it apart from the research that a buy-side analyst could perform themselves.