Security Analysis and Business Valuation on Wall Street,: A ... - lib

CHAPTER 2Who’s Practicing <strong>Security</strong> <strong>Analysis</strong><strong>and</strong> <strong>Business</strong> <strong>Valuation</strong>?In this chapter we discuss the individuals <strong>and</strong> firms that employ securityanalysis techniques. The role of the analyst differs, depending on the institutionalcontext.Hundreds of thous<strong>and</strong>s of individuals make their living from working in the capitalmarkets, but only a small percentage are full-time security analysts. About40,000 can be classified as practitioners. Perhaps 65 percent of them work for institutionalmoney managers such as mutual funds, hedge funds, pension funds, <strong>and</strong>insurance companies. These institutions invest their cash flows through the purchaseof securities, so the trade refers to them as the buy side. Approximately 20 percentof analysts work for securities firms, publishing research reports which are providedfree of charge to institutional <strong>and</strong> individual clients. These reports purportto sell an analyst’s investment ideas to an investor in exchange for fee-generatingbrokerage business. Securities firms are called the sell side. If an analyst issues arecommendation on a stock <strong>and</strong> the investor chooses to follow this advice, the analysthopes the investor executes the order through the trading department of theanalyst’s firm.A smaller group of analysts, about 15 percent, labor for credit rating agencies,market letters, <strong>and</strong> independent research firms. These enterprises market securityanalysis opinions either for flat fees or for shared commissions. Regulators such as theSecurities <strong>and</strong> Exchange Commission (SEC) <strong>and</strong> the Financial Industry RegulatoryAuthority (FINRA) also employ hundreds of analysts.The commitment of a firm to employing analysts is a function of its size, style,<strong>and</strong> activity. Fidelity, the mutual fund giant with $1.5 trillion under management,is an active stock picker <strong>and</strong> has over 500 analysts on staff. In contrast, BerkshireHathaway, Warren Buffett’s investment vehicle, manages $150 billion with only twoanalysts, Mr. Buffett <strong>and</strong> Charles Munger, a close associate. Vanguard Index 500,a $125 billion index fund, uses no analysts. Its portfolio deliberately mirrors thecomposition of the S&P 500, so stock pickers need not apply. Employing a full-timeanalyst is uneconomical if a fund’s size is less than $75 million. With this relativelysmall portfolio, the portfolio manager generates his own research or uses the sell-sidereports provided to him in exchange for brokerage commissions.17