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Channels of Information

Markets are only efficient when there's a free flow of information.  One of the channels of that information are the sell-side analysts.  I was one for a little over a year, and I can tell you that small-to-medium sized companies, even ones with significant coverage, were almost always happy to hear from us. 

We were their means of getting their stories out to the market at large.  While we were always honest, and always discussed the company's warts, we also wouldn't have been covering them if we didn't think they were a good investment.

Now, with the financial industry in flux, adn Wall Street hurting, there are fewer analysts around to cover stocks, and information flow may be suffering:

Lost coverage can be meaningful not just to smaller companies but to their investors. Analysts link corporate management with both institutional and, to a lesser degree, retail investors. Though they are faulted at times for being too cozy with companies and too bullish on their stocks, analysts build a mosaic of information and analysis that can help drive interest in a particular company. The good ones do an even better job of understanding when corporate operations are struggling and thus warn investors away.


Scholastic Inc., a publisher of children's books including the U.S. editions of the Harry Potter series, has lost coverage from Goldman Sachs, J.P. Morgan and Citigroup, among others, leaving only three analysts still tracking the company. One result: company executives now spend more time on the road, meeting with potential institutional investors, since Scholastic has fewer Wall Street analysts to pitch their story.

"It has changed how we communicate with investors," says Jeffrey Mathews, Scholastic's vice president of corporate strategy and investor relations. "We spend much more time with institutional investors than we did five years ago." Goldman said the Scholastic analyst left the firm and coverage was dropped. Citigroup declined to say why it stopped following the company and J.P. Morgan declined to comment.

Directly targeting institutional investors would tend to reduce the information available to smaller investors, and narrow the decision-making base.  Information flow is slower, and fewer people are making informed decisions; both these effects tend to degrade market efficiency.

This effect may be reversible, but another will be harder to undo.  In the past, analysts could content themselves with analyzing market forces, the actions of thousands or millions of actors.  The government is taking a much more direct role not only in regulation, but in credit decisions and the actual running of banks, credit companies, auto companies, and soon, the insurance industry.  More and more, the fate of companies will ride not only on management's ability to respond to its consumers' needs, but also on decisions made in Washington. 

Not only will the analyst have to read tea leaves to guess the direction those decisions will take, but he will also have to judge management's ability to do so.  This is going to make political analysis as important as economic and financial analysis, and it's going to make guessing the moods of a couple of dozen lawmakers as important as understanding a company's supply chain.

And you thought it was only the technical analysts who practiced black magic.

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