Frequently Asked Questions

 Is independent analyst coverage necessary?  

Ø Recommendation IV.P.4 of the “Final Report of the Advisory Committee on Smaller Public Companies to the U.S. Securities and Exchange Commission” states that “The trading markets for public companies are assisted in great measure by the dissemination of quality investment research”, and goes on to state that “the problem (with lack of coverage) is particularly pronounced in the case of smallcap companies, of which less than half receive coverage by even a single analyst, and in the microcap universe, where analyst coverage is virtually non-existent.”   (see footnote 143)

 Ø     This report goes on to state that “A lack of independent analyst coverage has several adverse effects, both for individual companies and for the capital markets as a whole.”

 Ø     Companies with no independent analyst coverage have a reduced market capitalization in comparison with companies that do have such coverage, and are subject to higher financing costs when compared with their analyst-covered peers; (footnote 146)

 Ø     A lack of coverage by independent analysts limits shareholders’ and prospective shareholders’ ability to obtain an informed outsider’s perspective on identifying strengths and weaknesses and areas for improvement;

 Ø     The lack of coverage lessens the entire “mix of information” made available to investment bankers, fund managers and individual investors, which makes markets less efficient; and

 Ø      Because analyst reports trigger the buying and selling of shares, the lack of such reports frustrates the formation of a robust trading market.” (footnote 147)

 (Report dated April 23, 2006;  see http://www.sec.gov/info/smallbus/acspc/acspc-finalreport.pdf#search=%22final%20report%20of%20the%20advisory%20committee%20on%20smaller%20public%20companies%22) 

 
Why should a company pay for analyst coverage? 

Following are additional excerpts from the above referenced Final Report of the Advisory Committee on Smaller Public Companies:

Ø     “Investment research for public companies in general, and for smaller public companies in particular, has declined dramatically in recent years, however, as economic and regulatory pressures have led the financial industry to dramatically reduce research budgets.” (Footnote 143)

Ø     Table 7 indicates that the mean # of analysts covering stocks with market caps under $25mm is 0.  The mean count increases to 1.4 analysts for companies with market caps from $100mm to $200mm, and to 17.2 analysts for market caps over $10 billion. 

Ø     Citing data compiled by StarMine, CFO Magazine reported in 1/05 that:  “This means that there are fewer companies being covered by analysts today (4,508) than at any time since 1995.” (http://www.cfo.com/article.cfm/3516678/c_3576955?f=home_todayinfinance)

Ø     The Advisory Committee goes on to recommend that the Commission “… Maintain policies that allow company-sponsored research to occur with full disclosure by the research provider as to the nature of the relationship with the company being covered”, and “…continue to search for new ways to promote analyst coverage for smaller public companies.”

The bottom line is that for almost all microcaps and many smallcaps, the analysts at issuer paid research firms are the only ones that are going to pay attention to these companies.

Ø     While the analyst recommendation and price target get the headlines, there is a great deal more to a research report than these two conclusions.  If the analysis of a company paid researcher exhibits bias, it is most likely to manifest itself in the buy/sell recommendation and in the price target.  However, the heart of the research report is not necessarily in these two data points alone, but rather in the balance of the report, especially the industry and competitive analysis, as well as the detailed examination of the issuer’s business and position in its markets.  A sophisticated investor should be less likely to rely on an analyst’s recommendation and price target, and more likely to make his or her own investment conclusions based on the company and market analytics provided by the researcher.  Any reader of research should utilize an analyst’s price target and recommendation with caution, regardless of how that analyst is compensated. 

Ø     Company paid research analysts often have licenses or designations accompanied by mandated professional standards and codes of conduct.  There is a saying that locks help keep honest people honest, and while professional licenses or membership in organizations such as the CFA Institute certainly in no way guarantee that analysts will act ethically or diligently, the threat of losing a license or the right to use a designation should be one effective safeguard to align the interests of analysts with the interests of the investment community.

 Ø      It is in the analyst’s self-interest to get the research right.  It stands to reason that a company paid analyst is interested in working as much as he or she is able, and charging the maximum rate that the market will bear for his or her services.  It also seems reasonable to conclude that the best way to achieve these goals is to earn a reputation for getting the analysis right.  To be effective in the long run, an analyst must earn the respect of the investment community.  Producing reports that are flattering to the company funding the research but short on real analysis may keep a company paid researcher busy in the short-term, but only at the expense of the analyst’s reputation in the long-term, which is no service to the analyst or to the companies he or she endeavors to cover.