A short report could be a negative read

A positive report does not necessarily mean the analyst is making a buy recommendation.

MUMBAI: Anjali Shah, an anchor with a leading business channel, had recently started seeing Rakesh Ahuja, a hot shot equity analyst with a brokerage firm that also offered investment banking service. They had already met a couple of times and their conversation mostly revolved around their work lives. Not the best way to start off, but at least they liked talking to each other, the most essential point for the success of any relationship.

Rakesh had been very busy the entire last week and so was Anjali. "Well, you look much better in real life," remarked Rakesh. "Hmmm! Guess the yo-yoying Sensex is not the only thing audiences are interested in," retorted Anjali.

"So what kept you busy last week," asked Anjali. "I was busy writing a research report for the initial public offer (IPO) of a company for whom we are managing the issue. We are also partly underwriting the issue," he said. "What do you think of the IPO," asked Anjali. "Not too great. The company is essentially making use of the bull market and raising money," Rakesh replied.

"So, you must have written in your report asking people to stay away from the issue," said Anjali. "No, I did not. I wrote a very short report," he replied.

"A short report?" asked Anjali. "I am a sell side analyst. A sell side analyst typically works for a brokerage firm, which also provides investment banking services. Companies going in for IPOs hire my firm to advise them in structuring the issue and also in raising the money to be collected through it. Other than that we also underwrite a certain part of the IPO. This is how my firm makes money and not through the research reports. My firm has substantial interest in ensuring that the IPO of the company is successful. Hence, my research cannot really be independent," Rakesh said.

"So given this scenario we need to write research reports that our clients would like investors to read, which may or may not give the real picture. This ensures that clients keep coming to us. Nobody likes firms whose analysts give negative coverage to a company," he added.

"And what else?" asked Anjali.

"Positive recommendations also help our firm generate and handle mergers and acquisitions for companies. Like, Mitch Zacks points out in his book, Ahead of the Market, "Imagine you are a CEO, about to make a tricky or questionable acquisition. As the CEO, you don't need help negotiating the deal; what you really need more than anything else is for your company's stock price not to tank after you make the acquisition. Companies engaging in acquisitions see their stock price fall for a variety of reasons, the most common being that the acquirer almost always overpays.

As the CEO, the best way to guarantee that investors don't flee your stock when you decide on acquisition is to make sure that one man on Wall Street who is trusted to predict your stock's future price supports the merger.

The best way to accomplish this is by paying the investment banking division of the brokerage firm that employs this top analyst tens of millions of dollars in fees. This may not assure you a "pound the table" buy recommendation, but it guarantees that you will receive a better recommendation than you otherwise would," replied Rakesh. "Ok! But why the short report," asked Anjali.

"Oh that's simple! That's my way of telling the investors to stay away. As Zacks points out in his book, "Analysts tend to follow the maxim your mother probably taught you: If you don't have something to say, don't say anything at all." Hence, most negative reports tend to be very short," replied Rakesh.

(The example is hypothetical)