For Buy-side Preparation: ER > IB

Many clients ask me: Should I do Investment Banking (“IB”) if I want to do equity investing? (“buy-side”). This week, I discuss with you why Sell-side Equity Research (“ER”) equips you with more relevant skills for the buy-side than IB.

My coaching style is to understand your final goal and solve it backwards. In this case, what skills do you need as a public equity investor?

Public equity investing entails understanding a company in the context of its competitors and its industry. Then you forecast the business outlook using your own assumptions. Finally, you value the business and compare against where the stock of the company is currently trading to identify potential mispricing.

The buy-side does not want to train junior people on foundational skills. So historically ER and IB as the two biggest talent funnels for public investing. The reason lies in the common skills developed in ER and IB:

  • Financial modeling and reading of financial filings. By extension, ability to make the proper adjustments for one-time items, ability to triangulate across filings and footnotes to piece together information, etc.
  • Valuation: Both ER and IB involve at least mechanically valuing the business using peer and precedent transaction valuation methods (and Discounted Cash Flow analysis sometimes in ER)
  • Finally, my personal favorite: General resourcefulness and work ethics. These are higher pressure professions with heavy workload and time sensitivity.

Why do I argue ER better prepares you for buy-side than IB? What incremental skills do you learn in ER that you are not exposed to in IB?

  • First of all, buy-side and sell-side research both deal with stocks. IB deals with transactions. So it should be intuitive more stock-related skills can be learned in ER than in IB.
  • Coverage skills:
    • A big transferable skill is the ability to constantly have views on news and events that could impact a company, which helps one distinguish between signal and noise over time.
    • Another core task of ER is to follow company’s quarterly earnings results, monitor how each story unfolds and assess whether the incremental data validate or refute the original thesis.
    • Research analysts on the buy-side do exactly the same tasks to the stocks already in the portfolio and also to their assigned sectors to identify future actionable ideas.
  • Access to investors. ER serves buy-side clients. That’s invaluable for many reasons: One, you are exposed to people who can hire you. Two, you learn why different styles of investors are long or short the stock at that moment in time. Three, you get to assess who is right in hindsight and understand why, which helps build pattern recognition.
  • Writing: A rather minor point, but writing helps organize thinking (I can attest to that as a blogger), which is important for an investor. ER professionals writes every day while IB spends completely unnecessary amount of time formatting presentations.

With all that edge on ER, I want to highlight unique talents investment bankers bring to the table:

  • Event-driven investing: Merger arbitrage funds will definitely be interested in hiring someone with an IB (especially Mergers and Acquisitions) background or a law background because they have experience understanding the price at and probability of a transaction taking place.
  • This is an angle where IB has an edge because their work centers around the transaction and ER people are more reactive to a transaction occurring and then just write a note assessing the financial impact of the transaction, if any.

The tough reality is fewer spots are available in ER because the research teams have few employees and they don’t leave precisely because ER provides RELATIVELY better lifestyle. So on an absolute basis, there will always be more investment bankers than ER professionals at any point in time. By extension, a higher absolute number of investment bankers have made it to the buy-side historically than ER professionals. 

So if you cannot get into ER, you should try for IB as long as you know what you are getting yourself into in terms of lifestyle. But my point is: If you are unfamiliar with ER, you miss out a great route to the buy-side.

Am I happy about this reality? No, but going direct to buy-side from undergraduate is much more difficult than lateraling from IB. So it is about choosing a path with less resistance.

If you are not considering just public equity investing, IB also provides optionality into transaction-based professions like private equity, growth equity, venture capital, or corporate development. (For corporate development, I have seen ER people break in as long as they cover the right sector, gun for the right firm and develop the necessary skills to do the job.)

The decision tree for those who want to do public equity: Choose ER over IB if you can land a spot, otherwise gun for IB. If you can get into neither, thanks to the proliferation of internet platforms, there are many unconventional ways of getting your work product seen online that help you build a brand and get buy-side job leads.

If you are interested in learning more about professional equity investing (the "buy-side"), I have two other great articles for you:

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