Research is a requirement, not a luxury

By Andrea Kirby

According to research from Thomson Financial First Call, more than half the companies quoted on NASDAQ are not covered by a single investment analyst. Yet 76% of investors say that they are more influenced by analyst research than by annual reports or any other information source.

The situation is equally bad in the UK. While most corporate brokers are still offering research as part of the brokership package, many are not updating their forecasts on a timely basis. Some are covering companies with junior analysts who don't know the sector in depth, and many analysts cover a diverse selection of companies and are unable to offer any real expertise on their clients' businesses. And most companies under £100m market capitalisation have a single forecast available - that of their official broker, who is hardly unbiased.

A single point forecast isn't enough

A single point forecast gives investors no view of the risk of investing in the company or the possibility of divergent outturns. If that single forecast is not updated to reflect corporate or market news, it is in effect creating a false market - a market in which investors may be buying on the basis of information which is out of date. Inevitably, it is more likely that the house broker will delay a downgrade of profits than an upgrade - which runs the risk of investors being brought into a company by a bullish forecast that no longer applies.

We believe the maintenance of research of a decent standard of quality and of forecasts at a high level of timeliness is vital to the creation of an efficient market in smaller company shares. Companies are required to maintain a market in their shares by having at least two market makers. They are required to file annual and interim reports on a timely basis. Attempts to increase disclosure have focused on adding corporate governance and accounting requirements to these basic reports. But we believe any attempt to create better disclosure for smaller quoted companies also needs to address the question of research - increasing both the quality and the amount of research.

Why broker research isn't adequate for smaller companies

Brokers are not going to be able to do a ssufficeint amount of high quality research. Frankly, no agency broker that isn't getting paid a corporate finance advisory fee is going to make enough from a £50m market cap company to pay for an analyst to cover it. Assuming the company had 50% free float - and a lot of SQCs have less - and that free float turned over once a year, and the broker got 50% of the market business in that stock, it would make them £15,000 at the most.

Nor can buy side houses invest enough to do their own research in this sector. While most houses have invested in their own analyst teams over the past ten years, no fund manager can afford to cover, in depth, the hundreds of smaller companies.

Why sponsored corporate research is the answer

Therefore, we believe the future lies with sponsored corporate research. Only a non-broking research house, which provides research as a dedicated service, can afford to provide it cost-effectively. Only such a house can provide dedicated sector research for SQCs - as Hardman & Co does currently in the technology and media sector. And only such a house can provide the backup resource in the sector, such as the TMT Monthly which follows trends in these sectors.

Hardman & Co is now developing further sector based products focused on investment trusts, pubs and breweries, and mining and minerals. We believe the sponsored research houses have to take up the future of providing adequate research on SQCs - because no one else is going to.

We also believe that the Stock Exchange should make the availability of two up to date forecasts a requirement of listing in just the same way that the support of two market makers is required. Research is not a luxury - it is a basic, critical factor in enabling an efficient and transparent market to exist.