Fee-Based Research: the Good, the Bad and the Ugly

Fee-Based Research: the Good, the Bad and the Ugly

Rick Wayman, CFA (ResearchStock.com)

Because it refers to something that bridges the information gap created by

Wall Street, fee-based research is a term that investors need to know

about. This article will define the term and discuss how to decipher the

good from the bad and the ugly.

Fee-based research is research compiled by an independent research firm

that is compensated by the company that is the subject of the report (also

referred to as the subject company). This research is different from

subscription-based research, whereby the reader pays for research reports

on a pay-per-view basis or with an annual-subscription. And like investors

using subscription-based research, investors using fee-based research need

to know how to tell the difference between legitimate, objective research

and reports written to manipulate stock prices.

The Good

Objective fee-based research plays an increasingly important roll in

todays market because it provides investors with information that would

otherwise not be available. To fully appreciate how important this

information service is, we need to review a bit of history.

In the beginning, the research departments of brokerage firms provided

research on stocks of all market capitalizations. Wall Street firms tended

to follow larger-cap stocks while regional firms followed

smaller-cap stocks in their backyards. This allowed small brokerage

companies to have access to capital, which allowed the small caps to grow

to a point at which they were discovered by Wall Street. And investors

saw that this was good.

But things changed when deregulation resulted in smaller commissions,

shrunken trading spreads, and industry consolidation. These events resulted

in a smaller number of larger firms, which focused only on

big-cap stocks because the big-cap stocks had enough profits to fund

research departments. Consequently, thousands of small and micro-cap stocks

were orphaned, dropped from research coverage, because they did not

provide enough profit potential to the brokerage firm. If a stock did not

generate a certain level of trading volume, or, if the company did not have

the potential for an investment banking deal of a specific amount, the

stock was dropped from coverage. This left thousands of companies in the

wilderness and unable to convey their story to investors. This was bad, but

investors seemed unaware of the change because they were worshipping at the

bull market of the late 1990s.

Onto the scene came fee-based research with a mission to bridge the

information gap and guide orphaned stocks to the promised land of investor

awareness. Legitimate fee-based research is an effective tool because it

provides investors with information that they would otherwise not receive.

The independent analyst spends a lot of time and expense preparing

fundamental research that is free to investors. In this way, the companys

information is made available to the widest possible audience.

The increased need for fee-based research has been recognized by the

investment community. In January 2002 the National Institute of Investor

Relations (NIRI) issued guidelines for the use of fee-based research.

The Bad

The bad thing is that for most of its history, fee-based research has been

used to manipulate stock prices. Unscrupulous firms used this research

and boiler-room operations to pump and dump stocks while supposedly

legitimate research was done by Wall Street firms. This resulted in a

stereotype that all fee-based research is illegitimate, but, while there

are still many cases of market manipulation, investors are taking a closer

look at fee-based research.

Investors read fee-based research because things changed in 2002. Wall

Street research is no longer viewed as legitimate since it has been tainted

by investment banking considerations. Realizing that the Street follows a

limited number of companies, investors today are more educated and are

looking for other sources of information.

The Ugly

The really ugly part of all this is that there are many small-cap companies

with good investment potential but remain orphaned because they do not

believe that investors give any credibility to fee-based research. They

continue to wander in the wilderness, expecting the Street to eventually

recognize their worth and start covering their stock.

As these orphaned companies wait for the Street, their competitors are

discovering that the orphaned shares are undervalued and acquire the

orphan. Based upon our research, the average take-out premium for an

orphaned company is about 20%. Had the orphaned company taken the

initiative to reach investors by using fee-based research, these orphaned

companies would probably not have left so much money on the table.

The Bottom Line

In this brave new world investors are more educated and are looking beyond

Wall Street for their information. Legitimate fee-based research is

becoming more recognized because it fills the markets need for objective

information. The challenge for both investors and small-cap companies is to

be able to differentiate between the good and the bad independent firms.

Fortunately, there are two good sources of information that will help

investors and corporate management spot legitimate fee-based research. One

source is an article entitled Six Signs of an Objective Research Report,

which I wrote in December 2001. In it I detail how a reader can determine

the objectivity of a research report.

The other source is the Research Objectivity Standards that have been

proposed by the Association for Investment Management and Research (AIMR).

Because it refers to something that bridges the information gap created by

Wall Street, fee-based research is a term that investors need to know

about. This article will define the term and discuss how to decipher the

good from the bad and the ugly.

The Good

Objective fee-based research plays an increasingly important roll in

todays market because it provides investors with information that would

otherwise not be available. To fully appreciate how important this

information service is, we need to review a bit of history.

In the beginning, the research departments of brokerage firms provided

research on stocks of all market capitalizations. Wall Street firms tended

to follow larger-cap stocks while regional firms followed

smaller-cap stocks in their backyards. This allowed small brokerage

companies to have access to capital, which allowed the small caps to grow

to a point at which they were discovered by Wall Street. And investors

saw that this was good.

But things changed when deregulation resulted in smaller commissions,

shrunken trading spreads, and industry consolidation. These events resulted

in a smaller number of larger firms, which focused only on

big-cap stocks because the big-cap stocks had enough profits to fund

research departments. Consequently, thousands of small and micro-cap stocks

were orphaned, dropped from research coverage, because they did not

provide enough profit potential to the brokerage firm. If a stock did not

generate a certain level of trading volume, or, if the company did not have

the potential for an investment banking deal of a specific amount, the

stock was dropped from coverage. This left thousands of companies in the

wilderness and unable to convey their story to investors. This was bad, but

investors seemed unaware of the change because they were worshipping at the

bull market of the late 1990s.

Onto the scene came fee-based research with a mission to bridge the

information gap and guide orphaned stocks to the promised land of investor

awareness. Legitimate fee-based research is an effective tool because it

provides investors with information that they would otherwise not receive.

The independent analyst spends a lot of time and expense preparing

fundamental research that is free to investors. In this way, the companys

information is made available to the widest possible audience.

The increased need for fee-based research has been recognized by the

investment community. In January 2002 the National Institute of Investor

Relations (NIRI) issued guidelines for the use of fee-based research.

The Bad

The bad thing is that for most of its history, fee-based research has been

used to manipulate stock prices. Unscrupulous firms used this research

and boiler-room operations to pump and dump stocks while supposedly

legitimate research was done by Wall Street firms. This resulted in a

stereotype that all fee-based research is illegitimate, but, while there

are still many cases of market manipulation, investors are taking a closer

look at fee-based research.

Investors read fee-based research because things changed in 2002. Wall

Street research is no longer viewed as legitimate since it has been tainted

by investment banking considerations. Realizing that the Street follows a

limited number of companies, investors today are more educated and are

looking for other sources of information.

The Ugly

The really ugly part of all this is that there are many small-cap companies

with good investment potential but remain orphaned because they do not

believe that investors give any credibility to fee-based research. They

continue to wander in the wilderness, expecting the Street to eventually

recognize their worth and start covering their stock.

As these orphaned companies wait for the Street, their competitors are

discovering that the orphaned shares are undervalued and acquire the

orphan. Based upon our research, the average take-out premium for an

orphaned company is about 20%. Had the orphaned company taken the

initiative to reach investors by using fee-based research, these orphaned

companies would probably not have left so much money on the table.

The Bottom Line

In this brave new world investors are more educated and are looking beyond

Wall Street for their information. Legitimate fee-based research is

becoming more recognized because it fills the markets need for objective

information. The challenge for both investors and small-cap companies is to

be able to differentiate between the good and the bad independent firms.

Fortunately, there are two good sources of information that will help

investors and corporate management spot legitimate fee-based research. One

source is an article entitled Six Signs of an Objective Research Report,

Because it refers to something that bridges the information gap created by

Wall Street, fee-based research is a term that investors need to know

about. This article will define the term and discuss how to decipher the

good from the bad and the ugly.

The Good

Objective fee-based research plays an increasingly important roll in

todays market because it provides investors with information that would

otherwise not be available. To fully appreciate how important this

information service is, we need to review a bit of history.

In the beginning, the research departments of brokerage firms provided

research on stocks of all market capitalizations. Wall Street firms tended

to follow larger-cap stocks while regional firms followed

smaller-cap stocks in their backyards. This allowed small brokerage

companies to have access to capital, which allowed the small caps to grow

to a point at which they were discovered by Wall Street. And investors

saw that this was good.

But things changed when deregulation resulted in smaller commissions,

shrunken trading spreads, and industry consolidation. These events resulted

in a smaller number of larger firms, which focused only on

big-cap stocks because the big-cap stocks had enough profits to fund

research departments. Consequently, thousands of small and micro-cap stocks

were orphaned, dropped from research coverage, because they did not

provide enough profit potential to the brokerage firm. If a stock did not

generate a certain level of trading volume, or, if the company did not have

the potential for an investment banking deal of a specific amount, the

stock was dropped from coverage. This left thousands of companies in the

wilderness and unable to convey their story to investors. This was bad, but

investors seemed unaware of the change because they were worshipping at the

bull market of the late 1990s.

Onto the scene came fee-based research with a mission to bridge the

information gap and guide orphaned stocks to the promised land of investor

awareness. Legitimate fee-based research is an effective tool because it

provides investors with information that they would otherwise not receive.

The independent analyst spends a lot of time and expense preparing

fundamental research that is free to investors. In this way, the companys

information is made available to the widest possible audience.

The increased need for fee-based research has been recognized by the

investment community. In January 2002 the National Institute of Investor

Relations (NIRI) issued guidelines for the use of fee-based research.

The Bad

The bad thing is that for most of its history, fee-based research has been

used to manipulate stock prices. Unscrupulous firms used this research

and boiler-room operations to pump and dump stocks while supposedly

legitimate research was done by Wall Street firms. This resulted in a

stereotype that all fee-based research is illegitimate, but, while there

are still many cases of market manipulation, investors are taking a closer

look at fee-based research.

Investors read fee-based research because things changed in 2002. Wall

Street research is no longer viewed as legitimate since it has been tainted

by investment banking considerations. Realizing that the Street follows a

limited number of companies, investors today are more educated and are

looking for other sources of information.

The Ugly

The really ugly part of all this is that there are many small-cap companies

with good investment potential but remain orphaned because they do not

believe that investors give any credibility to fee-based research. They

continue to wander in the wilderness, expecting the Street to eventually

recognize their worth and start covering their stock.

As these orphaned companies wait for the Street, their competitors are

discovering that the orphaned shares are undervalued and acquire the

orphan. Based upon our research, the average take-out premium for an

orphaned company is about 20%. Had the orphaned company taken the

initiative to reach investors by using fee-based research, these orphaned

companies would probably not have left so much money on the table.

The Bottom Line

In this brave new world investors are more educated and are looking beyond

Wall Street for their information. Legitimate fee-based research is

becoming more recognized because it fills the markets need for objective

information. The challenge for both investors and small-cap companies is to

be able to differentiate between the good and the bad independent firms.

Fortunately, there are two good sources of information that will help

investors and corporate management spot legitimate fee-based research. One

source is an article entitled Six Signs of an Objective Research Report,

Because it refers to something that bridges the information gap created by

Wall Street, fee-based research is a term that investors need to know

about. This article will define the term and discuss how to decipher the

good from the bad and the ugly.

The Good

Objective fee-based research plays an increasingly important roll in

todays market because it provides investors with information that would

otherwise not be available. To fully appreciate how important this

information service is, we need to review a bit of history.

In the beginning, the research departments of brokerage firms provided

research on stocks of all market capitalizations. Wall Street firms tended

to follow larger-cap stocks while regional firms followed

smaller-cap stocks in their backyards. This allowed small brokerage

companies to have access to capital, which allowed the small caps to grow

to a point at which they were discovered by Wall Street. And investors

saw that this was good.

But things changed when deregulation resulted in smaller commissions,

shrunken trading spreads, and industry consolidation. These events resulted

in a smaller number of larger firms, which focused only on

big-cap stocks because the big-cap stocks had enough profits to fund

research departments. Consequently, thousands of small and micro-cap stocks

were orphaned, dropped from research coverage, because they did not

provide enough profit potential to the brokerage firm. If a stock did not

generate a certain level of trading volume, or, if the company did not have

the potential for an investment banking deal of a specific amount, the

stock was dropped from coverage. This left thousands of companies in the

wilderness and unable to convey their story to investors. This was bad, but

investors seemed unaware of the change because they were worshipping at the

bull market of the late 1990s.

Onto the scene came fee-based research with a mission to bridge the

information gap and guide orphaned stocks to the promised land of investor

awareness. Legitimate fee-based research is an effective tool because it

provides investors with information that they would otherwise not receive.

The independent analyst spends a lot of time and expense preparing

fundamental research that is free to investors. In this way, the companys

information is made available to the widest possible audience.

The increased need for fee-based research has been recognized by the

investment community. In January 2002 the National Institute of Investor

Relations (NIRI) issued guidelines for the use of fee-based research.

The Bad

The bad thing is that for most of its history, fee-based research has been

used to manipulate stock prices. Unscrupulous firms used this research

and boiler-room operations to pump and dump stocks while supposedly

legitimate research was done by Wall Street firms. This resulted in a

stereotype that all fee-based research is illegitimate, but, while there

are still many cases of market manipulation, investors are taking a closer

look at fee-based research.

Investors read fee-based research because things changed in 2002. Wall

Street research is no longer viewed as legitimate since it has been tainted

by investment banking considerations. Realizing that the Street follows a

limited number of companies, investors today are more educated and are

looking for other sources of information.

The Ugly

The really ugly part of all this is that there are many small-cap companies

with good investment potential but remain orphaned because they do not

believe that investors give any credibility to fee-based research. They

continue to wander in the wilderness, expecting the Street to eventually

recognize their worth and start covering their stock.

As these orphaned companies wait for the Street, their competitors are

discovering that the orphaned shares are undervalued and acquire the

orphan. Based upon our research, the average take-out premium for an

orphaned company is about 20%. Had the orphaned company taken the

initiative to reach investors by using fee-based research, these orphaned

companies would probably not have left so much money on the table.

The Bottom Line

In this brave new world investors are more educated and are looking beyond

Wall Street for their information. Legitimate fee-based research is

becoming more recognized because it fills the markets need for objective

information. The challenge for both investors and small-cap companies is to

be able to differentiate between the good and the bad independent firms.

Fortunately, there are two good sources of information that will help

investors and corporate management spot legitimate fee-based research. One

source is an article entitled Six Signs of an Objective Research Report,