Bird-Doggin':

Yes, this is a bird-dog post! I wanted to introduce you to the following study which I believe has interesting implications for those of you who are regular readers of research reports. I found this paper, "Buys, Holds, and Sells: The Distribution of Investment Banks' Stock Ratings and the Implications for the Profitability of Analysts' Recommendations" (September 2005), at Brad Barber's research page.

Here's a citation for the work. If you are interested in this subject, I would recommend your reading the paper.

Barber, Brad M., Lehavy, Reuven, McNichols, Maureen F. and Trueman, Brett, "Buys, Holds, and Sells: The Distribution of Investment Banks' Stock Ratings and the Implications for the Profitability of Analysts' Recommendations" (September 2005). Available at SSRN: http://ssrn.com/abstract=495882

I've not paid much attention to the % of buy/hold/sell recommendations, but I will now having read this paper. The premise of the paper follows:

"This paper analyzes the distribution of stock ratings at investment banks and brokerage firms and examines whether these distributions can be used to predict the profitability of analysts’ recommendations."

The study has a comprehensive methodology which I'll skip in this post. But the result was this:

"Upgrades to buy issued by brokers with the smallest percentage of buy
recommendations significantly outperformed those of brokers with the greatest percentage of buys, by an average of 50 basis points per month. Further, downgrades to hold or sell coming from brokers issuing the most buy recommendations significantly outperformed those of brokers issuing the fewest, by an average of 46 basis points per month."

The study dovetails with NASD Rule 2711 which required greater disclosure on the part of investment firms relative to the market peak of 2000 (height of bullishness) and the subsequent market decline. Rule 2711 had to be adopted no later than 09.09.02 for member members. It is this regulation that requires each investment research report (among other things) to list the % of buys/sells/holds in its research universe. The authors have many tables, but I constructed this very simple table to show you the differences in the breakdown among all firms over the pre/post adoption period:

The redistribution is remarkable, is it not?

I will also selectively lift some points that I think are interesting (and I really encourage your reading the paper--it is very accessible to lay (that means me) readership:

• While a literature view conducted by the authors show, "banking activity has not been found to be associated with either less accurate or more optimistic earnings forecasts." (p. 7). They also note some contrasting studies that show that (1) lead underwriter recommendations are more optimistic than that of others; and (2) "the buy recommendations of independent research firms outperform those of investment banks, especially subsequent to equity offerings." (p. 8). That is something to be mindful of when reading a prospectus--and fits with Russell's (and my) prognostication skepticism!
  

• During the height of bullishness (pre 2000), "buy recommendations outnumbered their sell recommendations by more than 35-1.(p. 8)

• Post 2001, the number of companies in the coverage universe dropped due to (1) smaller universe of organizations due to business failure at the time; (2) brokers declining to cover organization's whose prospects are dimly viewed; and (3) cut back in research resources. (p. 11)

The paper provides an interesting historical view useful to a post-2000 investment recommendation view as well as empiricism regarding the value of upgrades and downgrades RELATIVE to the issuing organization's recommendation universe.