Downgrade Warning in Finance and Accounting - Assignment Example

Assignment, Finance and Accounting Financial Reporting and Analysis Week 7 ‘Downgrade Warning’ Q1 The “analysts’ independence” actually means the ability of the analyst to provide unbiased and objective oriented ratings (U.S. Securities and Exchange Commission, 2014). In most of the cases, the unbiased attitude of the analyst is compromised because in most cases, the companies finance them or they receive compensation from the companies on which they research. No company would pay fees to be projected in a negative limelight therefore; the fee-based research in most of the times is biased (Francis et al., 2004). The pressure of being paid by the similar company that the analyst is analyzing actually curbs the independence of the analyst (Palepu, Healy, and Peek, 2012). This is because the analyst has the obligation to portray the company that is paying him his salary in a positive limelight. The analyst has a lot of power in their hands. The meaning of this statement is that the analysis and the grading of the company actually guides the investors and helps them to decide whether to buy the stocks of the company. This is the reason that no company would want an analyst to portray them negatively because that would affect the behavior of their investors. Further a company who is paying an analyst to analyze their situation would never want the analyst gives them negative ratings. Thus, this is the pressure that the analysts face which reduces their independence. No, a “buy” recommendation on a stock after its price has fallen does not always mean that the independence of the analyst has been compromised. This is because the market may be under pricing the stock due to some other factors, which it did not understand. However, an expert analyst might be able to forecast the correct price of the stock, may see it increasing in future, and may recommend buying. Well the current position of the technology stocks after its crash in the past is not so stable. However, from the crash the technology stocks and the broader stock market have evolved a lot. Therefore, it cannot be conclusively stated that the analysts who are currently recommending investing in tech stocks and broader stock market lack independence. Q2 Peter Houghton’s memo says that the analyst has the responsibility towards the company either to incorporate the changes requested by the company or to communicate to the company clearly, why the changes requested by the company cannot be incorporated. The memo does not clearly express the curb on analyst’s independence but it hints towards it because the responsibility either to incorporate the change or to clearly communicate why the changes cannot be incorporated kind of thrust a pressure on the shoulder of the analyst and disables him to provide bias free research. No, it does not make any difference if the analysts are pressured to change factual evidences of the company. This is because the pressure to change recommendations and the pressure to change factual evidences are synonymous. The investors rely on the factual evidences and then they rely on the recommendations given by the analyst. If the factual evidences contradict with the recommendations provided by the analyst, the analyst himself may be deemed unfit to assess the situation properly. Q3 The buy side and the sell side are two types of analysts. The Buy side analysts usually are employed at large investment companies or institutionalized companies that deal in mutual funds, hedge funds, or even well known insurance companies. These analysts are mostly focus oriented and they concentrate mostly on the definite specific securities or definite sectors of such securities. The reports of these firms are mainly for internal use of the firms. Whereas, the brokers and the investment generally employ the sell side analysts banks and they deal in the investment decision division of the retail sectors. The recommendations and the ratings, which are provided by the sell side analysts, are utilized to make up a sell investment. The ratings and recommendations of these analysts are usually free of charge for the clients who are hiring the brokerage company in which these analyst work. The sell side analysts provide more detail-oriented reports, which are used in selling the securities. They are more detailed in nature than the buy side analysts are. If the sell side analysts sometimes understand that the stock has been undervalued, he will be unwilling to make a “sell” recommendation. Even if the buy side analysts have their own analysts they would always look into the sell side analyst’s reports because it would want to know how the sell side is rating their company. This is because if the sell side analysts rate the company negatively and recommend the investors to go forward with “sell” recommendation, then eventually the stock prices will fall. Q4 The sell side companies might normally offer a common courtesy of warning or informing the firms about the downgrading effect that they would experience by the recommendations given out by the sell stock side because that would help the companies to realize and find out the problems and correct them. Yes, this particular courtesy can be extended to warning the companies before hand and may be included in the good business tactics or policies. Mr. Barkocy thinks of the act of warning issued by the sell side analyst as a disservice to the analyst and even a disservice to the buy side. This is because he is of the opinion that the analysts are pressurized by the companies and even penalized for putting forward “sell” recommendations. Mr. Barkocy says that he is a representation of the buyer side that would be influenced by the “sell” recommendations. Further, he notes that if the sell analysts are unable to provide the raw facts or the facts for selling of the stock then it would also adversely affect the buy side analysts because they would also not be able to properly recommend the customers which stock to buy and hold. Further, if the sell side analyst does not provide the correct data the investors in the end may also suffer adversely for the wrong decisions taken by them in accordance to the sell side report. The sell side may ignore such criticism because the sell side analysts are mostly financed by the companies who do not want negative limelight to their stocks. Further, for a long time most of the analysts are encouraged to do away with negative research by both the corporate clients and the own bankers of the firms in which they are employed. Q5 According to speech of Arthur Levitt in January of 2001 in a speech in Philadelphia, he has commented that sell recommendation from an analyst is very much common. But we also need to understand that it is necessary for analysts to issue sell recommendations otherwise investors won’t understand that whether they need to sell the stocks or not and in which market condition they need to sell it. Analysts generally use various financial terms such as buy, long term accumulate, strong buy, long term over perform, hold-to, neutral to make the investors understand about their recommendations. But the meaning of the these terms may vary from company to company. Thus investors should carefully understand the definitions of all the terms used in different research reports rather than making a guess. Investors also need to consider the company’s disclosures related to what percentage of all the ratings comes under either in buy or sell categories. While financial analysts provide various important sources of information in recent market situation but investors also need to understand the probable conflicts of interest that might be faced by the investors. For example- sometimes analysts work in such firms which owns the securities that are analyzed by the analysts or sometimes analysts themselves owns some stocks of such companies which are covered by them. Thus in this case their analysis and recommendations might be biased atleast in some percentage. Thus for an investor it is necessary to have a knowledge of the stocks by themselves and do not completely depend on the recommendations of the analysts as human error might occur in the analysis. It is advised to the investors that they should completely depend on the analysts decision about whether to buy and when to buy, hold or sell the stocks rather they should do their own research about the company on which they are going to invest. Profitability analysis and trend analysis of the company is helpful in decision making whether to invest in the company or not. They also need tro consider the prospectus for new firms and annual orb quarterly published reports for the public listed companies with the SEC to understand that whether the particular investment is right for them or not according to their financial conditions. Thus it is the responsibility of the analysts to make their decision without any personal biasness and it is also the responsibility of the investors to do their own research before making an investment. References Francis, J., Chen, Q., Philbrick, D. and Willis, R., 2004. Security Analyst Independence. CFA Institute. Palepu, K., Healy, P. and Peek, E., 2012. Business analysis and valuation. 1st ed. Andover: South-Western, Cengage Learning. U.S. Securities and Exchange Commission, 2014. SEC.gov | Analyzing Analyst Recommendations. [online] Sec.gov. Available at: [Accessed 27 Aug. 2014]. Read More