How Many Sell-Side Analysts Should Your Company Have?

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What’s the right number of analysts for your company?
Each public company is different, and so are the analysts and investment banks that cover them. Analysts cover stocks for a host of reasons, including institutional (client) interest, liquidity, perceived valuation, potential upside, and investment bank relationships. Based on these factors, large-cap companies typically have more sell-side coverage than their small-cap counterparts, but this does not mean sell-side analysts ignore small-cap companies.

With the emergence of boutique investment banks and the traction they are gaining with institutional investors, small-cap companies with strong business fundamentals should be able to attract an audience of sell-side analysts. Determining the ideal number of analysts depends on the analyst and his or her reason for covering the company.

Why do analysts cover stocks?
What are the determining factors as to why an analyst would choose to cover a stock? Below are some of the top reasons and motivations behind why sell-side analysts cover particular stocks.

Sometimes analysts cover stocks based on personal and investment banking relationships.

Analysts can also seek to pick up coverage on companies that provide the next trending technology or device. While coverage from these analysts may be looked down upon by a small number of institutional investors, they play a very important role. They will most likely help a company raise additional capital, and they also become the company’s biggest advocate by reaching out to potential investors through non-deal roadshows (NDRs) and conferences.

Another reason sell-side analysts cover stocks is that they believe a company may be undervalued. Such analysts are usually very knowledgeable in their respective industry and have a strong following from institutional investors. Having coverage from these analysts can give a company creditability, which could drive institutional ownership.

Other analysts are industry experts who cover a company, no matter the size, because it is in a certain subsector. Depending on the size of the company, these analysts may or may not spend a tremendous amount of their time and resources focusing on a certain company under coverage.

What else do analysts provide?
No matter why they choose to cover a company, all sell-side analysts typically build financial models and provide quarterly and annual estimates to their clients and financial data consolidation firms. Financial data consolidators not only provide market news, but they also calculate consensus estimates, based on the most recently-published earnings models provided by the sell-side analysts. Sell-side analysts usually build their estimates based on industry research, market analysis, and experience.

Once an analyst is happy with his or her model, it is compared to the financial guidance provided by the company. Some analysts may alter their financial estimates to reflect corporate guidance, while others will not. Because corporate valuations are typically calculated based on reported quarterly revenue and earnings, it is important to have consensus estimates that are similar to company guidance. Having a larger number of analysts covering a company could help to smooth consensus estimates by lowering the impact of an estimate that is much different than the rest.

Conclusion
Sell-side analysts can be very valuable to public companies, but the number of analysts your company needs depends on why analysts are covering your company. Having several analysts from each of the groups described above is most advantageous, as each group provides something different. Regarding financial estimates, having at least five analysts writing research helps to lower the impact of outlying estimates.

While there is no perfect answer to the question of what is the best number of analysts to cover your company, having some amount of sell-side analyst coverage will benefit any company.

Greg Chodaczek, Managing Director

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