Investment Banking Analysts’ Recommendations: Be Aware and Decide for Yourself

  • Analysts related to underwriting TSLA’s capital raises upgraded the stock just days before the capital raise, twice.
  • Scientific research shows that analysts are strongly biased toward the goal their analysis has, be it underwriting, brokerage commissions or a fund’s short or long position.
  • The best thing to do for the individual investor is to learn about the potential bias an analyst could have and find more differentiating analyses before making a decision.


TSLA’s stock price has been falling since the last quarterly earnings report that showed a Q1 2016 net loss of $282 million and included an announcement for a new capital raise. The stock slowly declined from a high of $253 at the end of April to last week’s one-month low of $204.66 on Tuesday.

1 figure tsla one month
Figure 1: TSLA’s stock price in the last month. Source: Bloomberg.

A declining stock price is not good for a new capital raise as it makes the company issue more shares to get the necessary amount which further dilutes existing ownership. But then, on Wednesday a Goldman Sachs analyst upgraded Tesla Motors (NASDAQ: TSLA) to “buy” from “neutral” targeting a 22% upside with a target price of $250 in the next six months. Nothing uncommon except for the fact that 16 hours later and after a price jump of 3.3%, TSLA announced a new $2 billion capital raise round with the main underwriters being—guess who—Morgan Stanley and, of course, Goldman Sachs.

Something similar also happened in 2014 when on February 24, Morgan Stanley upgraded TSLA’s target price from $153 to $320 pushing TSLA’s shares up 14% for the day. The upgrade was followed by TSLA’s announcement of a new $1.6 billion capital raise on February 26. As this might be a coincidence, and only an SEC investigation could discover the truth, let’s refrain from conclusions here, but this situation is a good starting point for an investigation into the level of independency investment banking analysts really have and how much their analyses should be trusted. In order to avoid any conflict of interest investment banks are obliged to keep a “Chinese wall” between their research and investment-banking teams. This article will show that this is not always the case.

Scientific Perspective

A good but seldom used resource in financial analysis is scientific research. It is seldom used because it takes a long period of time from when the research is started to publication so the results often become obsolete, but they are scientifically correct and difficult to question, unlike journalists’ opinions.

University of Notre Dame researchers found strong evidence of conflicts of interest involving the investment banking and research departments within large financial institutions. Research shows that, albeit declining, analysts still tend to issue optimistic recommendations on firms with which they are affiliated through underwriting relationships. The research included: all US firms with listed common stock between 1996 and 2009 excluding financials, utilities and government agencies due to regulatory constraints and capital requirements, analyst recommendations prior to all public and private issues of equity and debt by the firm and M&A transactions, and 57 investment banks related to the underwriting of the above transactions. The results are separated into already sanctioned and non-sanctioned banks but paint a clear picture.

2 figure reccomendation bias
Figure 2: Recommendation frequency before investment banker related firm transactions. Source: University of Notre Dame.

Banks that were never sanctioned by regulators for conflicts of interest have a stronger bias towards “Strong buy” recommendations while sanctioned banks are more conservative with more “Buy” recommendations, but the general analysis is strongly skewed to the positive. In defense of investment bankers, they “eat their own cooking” as bank-affiliated investment managers tend to follow recommendations from own sell-side analysts.

Should You Listen to Analysts’ Recommendations?

Even if their analysis might be biased, analysts do provide added value by researching companies, asking questions at conference calls and giving their opinion. All this work certainly saves a lot of time for investors, but recommendations should not be accepted lightly. There are four types of analysts:

  • Buy side analysts that work for various funds and institutional money managers advising their company of what to do that often publicly disclose their analysis in order to promote the firm.
  • Sell side analysts that disclose their research to their clients.
  • Independent analysts that make a living from selling their research to investors.
  • Rating analysts that should independently assess a company and its investment rating in order to aid investment decision making.

All of these analysts have different goals, from the goal of earning a higher fee from underwriting commissions like the example at the beginning of this article, to providing valuable advice to clients, or just selling research. The important thing is to understand the potential bias an analyst could have before reading an analysis. By understanding the underlying reasons, it is easy to request research by other analysts with differing opinions in order to get a clear picture of what is really going on. A biased analyst does not break any laws if he omits certain information in order to make his view more plausible.

A 2013 study called “Inside the ‘black box’ of sell side financial analysts,” showed that on a sample of 363 analysts profitability of analysts’ own recommendations and accuracy and timeliness of earnings forecasts score at the bottom of the analysts’ compensation influence list.

3 figure analyst compensation
Figure 3: Influences on analysts’ compensation. Source: Brown et al.


The conclusion is very simple: the responsibility for any investment lies in the hands of the owner of the funds. Even when delegating investment decisions to someone, the investor still has to choose that person or firm in a sea of options. Therefore, the best solution is to educate oneself in order to see beyond analysts’ biases and make the best risk/reward investment decisions.

A good start is to understand from what perspective the analysis is written. An underwriting relation like from the TSLA case is a clear sign of an optimistic analysis, while a disclosed short position by a hedge fund is a clear negative perspective. Good sites to look for more information about analysts are the SEC and FINRA’s reviews of analysts recommendations.