Brokerage firms’ main duties are to assist the investor to transact, and they do a good job of facilitating trades between buyers and sellers, including dealing with the administrative aspects, such as the settlement and delivery of shares.
Most firms also maintain a research team which consists of a group of analysts who visit companies and write recommendation reports to assist their clients with investment decisions. It is well-known within investment circles that most of their reports are heavily skewed towards “buy” recommendations, and an informal survey found that of all investment reports released by brokerage firms, 85% had a “buy”, 10% had a “hold” (i.e. neutral) while only 5% recommended a “sell”.
Here are three reasons why most brokerage reports have a “buy” call.
Much More Opportunities For Buying, Rather Than Selling
The logic goes – if you don’t own shares in a company, then you can only buy it. The proportion of people who do not own shares in a given company is much larger than those who already own it. Therefore, it makes sense for a brokerage to recommend a “buy” in order to encourage more trading commissions and fees for their own benefit.
Maintain Good Relations With Company’s Management
Analysts who write positive, glowing reports on a company are favoured by management, while analysts who write negative or scathing reports often face criticism and are ostracised by both management and the investment community.
Hence, there is a lot of social pressure to write something positive as it is good for the business and also encourages more people to transact with the firm. There have been cases where analysts have been excluded from earnings calls because they said something negative in their reports, and in more extreme cases, some analysts have even lost their jobs for being too candid in their assessment of a company (though this is not something which is publicized).
Natural Preference For Optimism
Human beings have a natural tendency to prefer good news over bad, and analysts also play along as this will encourage more people to read their reports and act on their recommendations. After all, who would like to be a harbinger of bad news and negative thoughts? This natural preference for optimism translates into reports which tend to accentuate the positives and downplay the negatives (i.e. risks), to the detriment of investors who rely heavily on such reports.
Foolish Bottom Line
Investors should, thus, practice critical thinking when reading brokerage reports and decide for themselves if the logic behind such buy recommendations is indeed sound.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.