Equity Research is such a confusing term when we break down what it provides and who provides it. If you look more closely at how a typical Broker/Banker firm generates revenue – it starts to make more sense. Research is a by product of the long held Capital Market Structure which begins with the fat fees generated by the investment baking arm who bring companies public, provide secondary offering services and merger and acquisition advice.

They have another revenue arm which churns on a daily basis with a paid market making team who provide liquidity, and waddles eventually to the research function who understand the industry (often) better than the company itself. These 3 uneasy bedfellows make up how capital markets have worked ( in some version of this) for hundreds of years, and it isn’t changing anytime soon.

Lets start with investment banking. Every banker lives for the big fee, and they all play the long game. In fact market making and research are by-products and if bankers had their way, they would jettison this portion of the business as loss leaders. In fact they do this often and outsource both which has diluted the services and driven costs down for these stepchildren. There are fewer market makers and fewer good analysts in 2017 than in years past. The good analysts are 50+ guys who know everything about the sector they specialize in and have Lexus payments. There used to be hundreds of good analysts in the 1980s and 1990s but most have left this side of the business as the economic pie has shrunk in lockstep with spreads. Additionally, the focus of the analysts has, by necessity, been on the largest, most liquid stocks as these are the names in which the banks can get paid.

This is perverse for the investor since the exact opposite end of the market – smaller and less liquid stocks – is where the information asymmetries are and where a good analyst can have the greatest impact. The tide of young new analysts has not surfaced as the smartest minds followed the trends in writing software code,designing apps or big data analysis. Being an Equity Analyst is not as sexy as it was in 1980 and 1990, mainly because it was second to launching a start up in terms of payout.

Capital Markets work like this Banking/Market Making/Research

Bankers Collect Fee’s (Big Fee’s long sale cycle)

Market Makers provide volume and liquidity (breaks even)

Research pumps out reports and buy or sell ratings (loses money)

So lets get back to Lumber Liquidators (LL) and how they solve the current problem they have with the analysts covering them.

  • Analyst cover them for the wrong reasons, and this is disguised as good for the company. If the advice the banks offered was so good, how did these analysts not see the tidal wave coming of illegal activity in a poison product that nearly killed the brand. The answer is they only gave a crap about the fees.
  • The good news is it didn’t kill the brand, so what now? Shares were $120 in 2013 and are near historic lows now. Time to change the way you talk to investors. Lumber Liquidators (LL) should talk to the investors at the retail level, and tell them why they are a good investment as well as a good place to buy the product. This is easily done using their database. Do not depend on the analyst coverage to benefit anyone but traders who do not care what direction share prices move.

Shares in LL need to close above $20 and stay there to make this stock safe again hoping for a return to the salad days. But more importantly the company should consider privatizing and focus on running the business versus having the procto-scope of fee mongers hovering over them. Get back to managing the business and stop worrying about managing analysts and the banks. I fully expect investor groups to examine the cashflow and brand damage done here to determine if it is worth buying the run rate.

We think simply watching pricing and learning more about how they intend to recover the brand will be the metrics to watch. If they go private it will be at a premium, not a bankruptcy. My suggestion is to go in the store and see how it feels to review products and how sales people are operating. This is a good channel check. My other suggestion is DO NOT listen to the analysts, but most investors don’t get to see the Goldman report anyway that is held for someone willing to pay for it with commission.

———————————————————-

We will be rolling our our portfolio in upcoming weeks one sector at a time…sign up below or ping us at the email below.

————————

Email me [email protected] if you are a Public Company and would like to see our Testimonials

Click Here if you are an Investor and want to sign up for our Friday Newsletter

Click Here to be part of the Equities.com Database