Stock Research: An Uncertain Future

Individual investors are rapidly losing sources of analysis and advice, as money set aside for independent research dries up and Wall Street firms slash budgets

By Ben Steverman

For the average individual investor, getting good information on stocks and other investments has never been easy.

It's about to get more difficult.

Fewer analysts are covering fewer companies. This trend of shrinking coverage is expected to continue for two reasons: The financial woes of Wall Street firms and the end of a five-year settlement to fund independent equity research.

Furthermore, top analysts are setting up their own firms (with limited client lists) and moving to hedge funds or other "buy-side" institutions. That means much of the best analysis is going behind closed doors, where it's harder for individual investors to access.

Independent Research Agreement Expires

Complaints about the quality of Wall Street research are not new. Five years ago, ten major Wall Street firms agreed to provide customers with independent research to settle claims that their in-house research was biased.

That agreement, which set aside about $90 million per year for independent research, ends in July.

Two of the biggest providers of settlement-funded research have been Morningstar (MORN) and Standard & Poor's. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP).)

Morningstar has disclosed that research settlement money made up about 4% of its 2008 consolidated revenue, about $20 million. According to Sanford Bragg, chief executive of Integrity Research Associates, which tracks trends in the equity research industry, S&P seems to be receiving a similar share of settlement dollars, with another smaller but significant share to Argus Research. "The majority of independent providers were getting zero or small amounts," Bragg says.

What's Next for Top Analysts?

Both Morningstar and S&P say they will continue covering a broad array of stocks. Even if the big investment firms stop paying for the research, executives at Morningstar and S&P say they will continue selling it through other channels, including their own Web sites.

"We'll continue to have broad coverage," says Catherine Odelbo, president of Morningstar's equity research group. However, she adds, "We may adjust that coverage based on client demand."

Under settlement research contracts, certain firms must be covered, even though "we know for a fact that no one is interested in them," she says. "We'll have a lot more freedom to adjust the coverage," she added.

Odelbo and Stephen Biggar, head of equity research at S&P, both say they're in negotiations with investment firms to continue providing them with research.

"They're in the decision-making process right now," Biggar says. Thus, the amount of Wall Street dollars for independent research "wouldn't go … to zero."

Wall Street's Shrinking Research Budget

However, the big firms that having been paying for research are in no position to be generous. Several—Lehman Brothers, Bear Stearns, and Merrill Lynch—no longer exist as independent entities. The survivors on Wall Street are laying off thousands of employees and are still navigating the worst financial crisis in a lifetime.

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