Tell an investor in the US that you’re writing an article on sell-side credibility and you invariably hear laughter, followed by something along the lines of ‘What credibility?’ Query investors in Europe, on the other hand, and you’re asked to explain the question. Apparently sell-side conflict of interest has yet to make such a big stir in Europe, unlike the US where it’s well known that analysts pitch investment banking business. And once a company becomes a client, the pressure to remain bullish can eclipse any semblance of impartiality – at least that’s the charge.
Added to this is the cozy relationship between companies and analysts: a company projects its growth rate, analysts adjust their models, and everyone falls in line with a consensus earnings per share number that the company often beats. Fall out of line and the analyst might face diminished access to the company or reduced investment banking business. These are the charges in North America, and they’re widespread enough to represent a crisis of perception, at least.
Not here, not here!
Opinions in Europe are varied when it comes to the question of credibility. But there is a common thread: the situation is nowhere near as bad as it is in the the US. As one UK sell-side analyst puts it, investment banking in Europe hasn’t grown to such outsized proportion and influence: ‘European investment houses make more of their money from secondary business than in the US, and there’s more of a tradition of research independence.’
Liz Christie has been on both sides of the equation. Now the head of IR at London-based Thames Water, she spent 13 years as a securities analyst at major firms including ABN Amro, Merrill Lynch and Goldman Sachs. To her, the idea that investment banking corrupts analysts’ objectivity has always seemed more negative perception than reality.
‘Some investment banks have a reputation for being driven by their corporate business,’ she acknowledges. ‘But I think that’s overstated. The conflicts were never as pronounced as people from the outside seemed to think. But you do see instances where negative reports cause some ripples or where a CEO expects their broker to issue a buy recommendation. Those are very isolated instances. Coming from my background, I think it’s unwise for a company to react negatively to what analysts say. It’s more important to check what they may have misunderstood and make sure they know the correct information for the future.’
Aymeric de Villaret, an oil analyst for Société Générale in Paris, says there has been a credibility problem in France, with the paucity of sell recommendations raising alarms. But he also detects signs of improvement. ‘I think it is getting better. It’s possible to be much more negative today. Five years ago, you couldn’t be negative. But I think companies know that if we are always positive, our credibility disappears, which is what was happening.’
Longer-term focus
Perhaps the most frequently cited factor that has helped keep the UK and continental Europe from falling into a US-style credibility crisis is the reporting structure. The majority of companies continue to report their results on a semi-annual basis, compared with the frantic quarterly pace set in the US. But this is changing quickly.
‘We have had a quarterly reporting policy for a couple of years, and this is the usual standard in our industry,’ says Stefan Gruber, director of investor relations at Germany’s SAP. ‘We are the largest software company in Europe, and many of our peers are US competitors. Overall there is a trend toward more continuous reporting. I think most European companies will probably begin reporting on a quarterly basis within a couple of years, though it depends on their industry.’
Many argue, however, that even if companies do begin quarterly reporting, this doesn’t necessarily mean the Europeans are bound to face the messianic draw of earnings numbers which has led to increased volatility in the US. ‘You don’t see this incredible focus on consensus estimates because the services that track the consensus don’t exist,’ explains Christie. ‘Moreover, there isn’t that same focus on the per share numbers. Here we talk more about pre-tax profits, which takes the focus off EPS.’
Because the emphasis isn’t on one number – EPS – and because investors aren’t sending stocks plummeting or skyrocketing based on tiny differentials from this consensus, the focus is on a broader array of indicators. ‘As an analyst, I used to always offer companies the chance to look at my numbers and was happy to hear their comments,’ Christie admits. ‘Now on the corporate side, I’m very keen to do that. What usually happens is that they’ll give us a profit or loss report with a number of inputs, and we can remind them of facts that are in the public domain that they may have overlooked and which may have a bearing on their forecasts.’
Christie is quick to note that while guidance takes place, the selective, cozy communications between analysts and companies that have been a point of controversy in the US are far from the norm. ‘The London Stock Exchange rules about indications to particular audiences are quite tough,’ she observes.
Specifically, the LSE requires that listed companies provide the exchange’s company announcements office with any information that is price sensitive. The office then distributes the information to the media. While the rules differ from country to country, many professionals agree that the disclosure playing field is level. ‘I would say selective disclosure is not a problem,’ says Martha Josefsson, chief investment officer of Carlson Investment Management’s Swedish office.
The critics
But while Josefsson discounts the issue of inadequate disclosure in Europe, she is far more critical of the system. As she sees it, the independence and objectivity of European analysts is in jeopardy. The difference is the spotlight hasn’t been turned on the problem.
‘I think that the US is much more focused on the issue of credibility, but that doesn’t mean that the problem isn’t as severe in Europe. We just haven’t had that kind of focus. Also, there is much more research in the US, so companies can be more selective, and therefore selective in their disclosure,’ she says.
Why the lack of attention? First, continental Europe and the UK have not experienced the explosive growth of online trading and the overwhelming participation of individual investors that the US markets have witnessed. And, second, analysts have not become household names due to relentless media appearances. But the lack of attention doesn’t mean complacence.
‘There are a number of a reasons that we have embarked on a separate research capability for European investments,’ says Mike Bishop, head of pan-European equities at Morley Fund Management in London. ‘Increasingly, fund management groups aren’t the sell-side’s most important clients anymore. Often some of the best analysts seem to be working harder for their corporate clients than they are for research clients – the institutions. So I think there is a growing suspicion over the independence of analysts. Not that it’s a new concern – a lot of the buy side has been skeptical for some time.’
To Josefsson, it isn’t a question of whether or not Europe will withstand the public’s growing fascination with all things equity, or the emergence of the star analyst; it’s a question of when. ‘I think the guidance game goes on as well. Investment banking here is also taking off and, with that, the research is getting too close to the investment banking side. And the media are paying more attention to the markets as well.’
Experience both sides
Colt Telecom Group is listed both on the London Stock Exchange and on Nasdaq, giving its director of IR, John Doherty, a broad perspective on the differing relationships between analysts and IROs in the US and the UK. Despite the US fascination with quarterly earnings and the volatility that can breed, he doesn’t fret over the idea that analysts have lost their objectivity.
‘Clearly some strong investment banking/corporate relationships are out there. But my experience has been that the vast majority of sell-side analysts are independent,’ he says. ‘Bearing in mind that all brokerage research is primarily for institutional investors, I think there’s enough disclosure.’
But Doherty acknowledges that the high profile media attention analysts receive in the US can be harmful to individual investors, who may not be aware of the investment banking ties when they see an analyst quoted on television or online. ‘But that situation isn’t here [in Europe],’ he notes.
As for the earnings guidance in the US and the scorn it draws, Doherty says Colt Telecom Group has resisted the practice. ‘If analysts want to send us their model to review, we’re happy to do it. But we don’t give specific EPS guidance, just as most companies do not in continental Europe or in the UK. If asked, we may say we’re comfortable with the range of estimates out there, but that’s as far as it goes.’
