All Research Reports Have a Bias

All research reports have a bias.  The most common reports are published by Wall Street investment banking firms, also known as “Sell-side” firms.  As the name suggests, they have something to sell (stocks) through their brokers and they do a lot of M&A with their clients (public companies), so their bias is to be positive and have a recommendation to “buy” or at worst “hold” (something like only 8% of ratings are “sell”).  Because of their positive bias, sell-side analysts are often not especially critical or thorough in their research, frequently tout what company management says (which obviously would only be positive for their company), and ignore or downplay negative developments.  If a recommendation to buy is wrong, they don’t lose money, but if correct they could at least indirectly make money through more investment banking business.

A few research reports are issued by short sellers.  Short sellers borrow common stocks they believe are at a high price, sell them, then when the stock price falls they buy at the lower price (“cover their shorts”), return the now-cheaper borrowed stocks, and keep the difference as their profit.  Contrary to what politicians, inept executives, and other ignorant people say, short sellers are not evil.  They play a vital role in the health of financial markets, in large part because of the hedging role they play to mitigate risk.  Obviously a report issued by a research firm that has a short position will have a negative bias, since they want the stock to go down for them to profit.  However, even though they have a bias, quite often reports issued by short sellers are much more thorough and go far more in depth about the company’s business.  This is because they cannot afford to be wrong too many times:  if the stock does go down, they make money, but if they are wrong and the stock goes up they lose money.  Not only that, but what they can make is limited since the worst any stock can do is go to zero, but theoretically they can lose an infinite amount of money because there is no cap on how high a stock can go.  In other words, short sellers are taking a real risk with their money, while in contrast investment bank analysts are not taking any monetary risk.

Some accuse short sellers of spreading lies about a company in order to move the stock down.  Spreading lies to achieve one’s aims is wrong and anyone who does so should be prosecuted.  And it is just as wrong to spread lies to move a stock up.

Finally, companies don’t like being the target of short selling, even if no lies are involved.  The best defense against this is to prove the short sellers wrong through strong business performance.

 

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