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Buy Side vs. Sell Side Part 1 – The Sell Side

So you want to be an analyst, do you want to work on the buy side or the sell side?

If your first thought was – “Huh?” – keep reading.

All equity and credit analysts perform research in order to make buy and sell recommendations. The ultimate user of those recommendations and the clients who pay the bills determine if you are on the buy side or the sell side. Part 1 will discuss sell side analysts and Part 2 – you guessed it –will discuss buy side analysts. Finally, Part 3 will wrap everything up and help you decide which career path is best for you.

Part 1 – Sell Side Analysts

Sell side analysts, also known as equity research, are generally the analysts you see on CNBC and Bloomberg touting stocks. They perform research and make recommendations that are sold to others to use – this is why you see them on television. Sell side analysts do not use the research for their own portfolios, their goal is to sell their research to others to use in their portfolios. Generally, their research is sold to the buy side – buy side analysts are the clients of sell side analysts.

Sell side analysts closely follow companies and issue research reports and earnings models for their coverage universe. Their coverage universe is usually focused on a specific niche or sector. If you’ve ever listened to a company’s quarterly conference call, then you’ve listened to sell side analysts as they are typically on the calls asking questions of management. Rarely do you hear buy side analysts asking questions on the call, although we are listening.

One key difference between buy side and sell side analysts is the role of marketing. Sell side analysts spend a large amount of time talking to existing clients and potential new clients about their research. Their job is to convince institutional investors (i.e., buy side analysts) that their research is worth paying for – either through trading commissions with their firm or through soft dollars if the firm does not have a trading desk.

Trading commissions? Soft dollars? WTF?

Backing up a bit, sell side analysts are typically employed by two types of firms: the large, bulge bracket brokerage houses and investment banks that are household names or smaller, boutique research shops that only provide research. The larger firms have trading desks, so a portion of the trading commissions generated are paid in exchange for access to that firms sell side research. For the smaller firms without trading desk, the research is typically paid through soft dollar agreements (this is a topic for another time).

Another key difference between buy side analysts and sell side analysts applies to those sell side analysts at the large brokerage firms that have investment banks. One role of the investment bank is to raise capital for public companies – the same public companies that its research analysts cover. This creates a serious conflict of interest because the investment bankers don’t want its research analysts slapping SELL ratings on companies where they are trying to raise capital. Sarbanes-Oxley has rules that strengthened the Chinese walls between the research groups and the bankers, but the internal conflict is still there and evidenced by the very high percentage of BUY recommendations issued by analysts compared to an almost de minimis number of SELL ratings.

At the end of the day, sell side equity research is part of a triangle that also involves sales and trading. The way it works is this: equity research generates investment ideas, sales pitches the ideas to investors (buy side clients), and then the buy side clients execute the investment ideas through the traders to generate commissions, which is how they all get paid.

{ 2 comments… add one }
  • Gregster

    You are not emphasizing how much sell-side is about selling, and how ridiculous the conflicts of interest are. Why issue a sell on a stock you want clients to buy? In the time before the crisis, 99% of stocks got a buy.

    Also sell-side analysts always have a ridiculously short-run view, and don’t just look at fundamentals, but also at the marketability of a stock. In fact they seem to completely ignore the fundamentals.

    They don’t have the cohonas to say buy, if everyone else says sell. Stocks are perpetual stakes in the cashflows of a business after debt servicing. Not some abstract financial product called “stock”.
    Their analysis motivates high portfolio turnover = high fees + taxes + reduced quality analysis of investments, going with the crowd, changing your opinion all the time.

    Just outrageous.

    There are some extremely high quality brokers, which I won’t mention because people might take it as advertisement. But they have to be independent, long-run oriented. Nice if they have a succesful fund themselves too. Look at who someone like Buffett works with.

    • While there are conflicts of interest on the sell-side, I believe your view is too cynical and lacks real world experience. The buy side directs flow to the shops with the best research and trading execution. We don’t just buy or sell stocks because a sell-side analyst says to do it.

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