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The Sell-side Analyst as Secret Agent: Control v. Kaos


Over fifty years ago, the secret agents of Control battled the forces of KAOS in the American TV classic “Get Smart.” Whether you think Agent 86’s shoe phone or his miscommunication with The Chief under the “Cone of Silence” is a more apt metaphor for the work of today’s sell-side analysts, you probably haven’t thought of them as secret agents fighting the forces of chaos. The last of the Get Smart spin-offs and revivals was a 2008 feature film, released just as the panic of the global financial crisis began to spread. Ten years later, the world of institutional investment enjoys more transparency, but a sense of peril grows each quarter. The mysterious MiFID II lurks around every capital markets corner, hiding whether it’s a global force for good or evil for sell-side analysts, institutional investors and IROs. Equity markets continue to march ahead (sometimes in circles) as investors’ direct access to management, news, information and analytics keeps increasing… and the international turmoil of the next major equity market crisis looms.

Sell-side Analysts Help Control Equity Market Communications Chaos

From an investor’s perspective, corporate IR and capital markets communications is a chaos of words, numbers, pictures and group and one-on-one meetings that must be brought under control for investment decision-making. One of sell-side research’s major contributions to 21st century cross-border capital markets has been overlooked in the MiFID II discussions regarding its value: A group of competing analysts following the same companies navigates accounting, regulatory and communications chaos and generates timely, concise and easy-to-compare research reports that meet the (sometimes conflicting) demands of different investors around the world.

Rabbit Ears and Rotary Dials Times Infinity

Today’s equity markets are global, closely linked and tightly wound around technologically advanced communications channels. But today’s mobile devices and desk top screens convey the same words, pictures and sounds as did “TV Guide” magazine, the grainy pictures of 1960s black and white TV sets, and Maxwell Smart’s rotary dial shoe phone. The real difference today is the immediacy and amount of content. Multiply the units of information by any number of billions to try to imagine the difference between the inputs presented to professional investors today compared to when Get Smart was on TV. The essence of capital markets communications content has remained about the same, but the growth in the amount and its speed of delivery is incalculable.

Triggering the Mole Cells

IROs should not ignore the importance of the unconscious collaborations of competing sell-side analysts from different firms following the same companies. Regardless of whether they work for bulge bracket brokerages or boutique research firms, communities of analysts covering sectors across borders work together to bring a comprehensible level of order to the chaos of cross border financial reporting standards, accounting conventions and company specific KPIs and idiosyncrasies. Triggered by company and industry news, they quickly frame the ways investors react to announcements and changes in management guidance disclosed and presented in very different ways. Equity research analysts report on the investment narrative while shaping it from the perspectives of their own expertise, their firm’s macro and market commentary, and their institutional clients’ interests. Managements usually place too much emphasis on the range of analysts’ numerical estimates (“Missed it by that much,” as Agent 86 would say) and not enough on the impact of the collective key messages and concepts in sell-side research notes, and the ways these impact different investor groups over time.

Deciphering Encrypted Company Code

Management speaks in a kind of code, thus its key messages are understood and appreciated by only its closest sell- and buy-side followers who are familiar with this code. Their code is not as accurately unlocked in their home capital markets as managements and IROs imagine, across borders and oceans it becomes practically undecipherable. All but the most straightforward guidance gets lost as investors simply don’t have the time to decipher and compare managements communicating in their own variations of key messages and guidance code. Earlier this year, we completed a major research project to review in depth the capital markets communications of 22 peer companies of a large cap client who competes across Europe, North America and Asia. Its industrial peers are listed (including dual listings) on 10 different stock exchanges and report in seven different currencies. Researching an industry which globalized across both commercial and capital markets in the last century, we expected to find relatively consistent market driven patterns of KPIs, guidance formats, capital allocation frameworks, etc., highlighted in comparable company’s investor relations and capital markets communications. Instead, we were surprised at the extent of the inconsistencies in this closely comparable peer group, including significant variances across peer companies from the same capital market.

“Do as I Answer, Not as I Disclose”

We looked in detail at key capital markets communications channels, ranging from regulatory filings to capital markets day presentations and conference call transcripts. We compared the ways hard and soft guidance were presented, what was disclosed in a news release versus the “color” in a conference call answer. We included management’s tone and communications style in the considerations. The findings were organized around the framework of IR information and management communications that Taylor Rafferty has identified as most important to investors’ perspectives on relative valuation. The ways management guided investors to manage their expectations varied significantly even when peer companies reported within the same regulatory guidelines. Among the information sources prioritized by investors, KPI’s and the investment narratives highlighted in sell-side reports were the most consistent and easily comparable across the range of 22 companies. Analyzing sell-side reports with a focus on their key message’s relevance to different investor groups should be a fundamental approach to benchmarking IR.


The Secret Code of Analyst Conduct

The sell-side research community serves as a mission-critical component of the cross-border capital markets, applying consistent narrative templates and comprehensible commentary to companies that compete halfway around the world from each other, speaking in different languages with various hybrids of English serving as the lingua franca of the financial community. And while the analysts themselves often write for local and long-time company follower mindsets, this provides vital “local color” to foreign investors that follow the company. Regardless of their individual styles and the priorities of their institutional client base, all sell-side analysts are subject to the discipline of communicating their estimates and verbal commentary into internationally comparable formats reflecting similar compliance and regulatory considerations. Circulating them as pdf attachments in a group email to management and advisors is too often the substitute for the IRO analyzing sell-side analyst reports against agreed capital markets goals and IR messaging priorities.

“Would you believe…”

As Maxwell Smart would put it, “Would you believe sell-side analysts are indispensable in the global fight against international capital markets chaos?” For management, investors and IROs alike, appreciating the ways sell-side analysts “secretly” work together is essential to decision-making in the chaos of capital markets and IR communications relying on different regulatory/accounting standards, non-GAAP KPIs, types of guidance, time frames for targets, etc. And if you believe the ‘death of the sell-side analyst’ story lines, well, “Sorry about that, Chief.” And for any reader skeptical of assertions that very few of the most important things have changed in the capital markets over the last four or five decades, here’s the way KAOS was described in a mid-1960s episode of Get Smart:

“KAOS, a Delaware Corporation (for tax purposes).”

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