What is Covered Stock (Coverage)
A covered stock is a stock for which a sell-side analyst publishes research reports and investment recommendations for clients. Upon commencement of coverage, the analyst will publish an "initiating coverage" report on the stock, and subsequently issue updates after quarterly and annual earnings or after material news for the company that may impact the stock.
BREAKING DOWN Covered Stock (Coverage)
Many brokerage firms provide proprietary research reports to its institutional clients as well as important retail (high net worth) clients. The purposes of these reports are to support investment decisions of its clients and to generate trading commissions for the broker-dealers. A sell-side analyst conducts thorough research on a company — its business model, competitive advantages, principal risks, management quality, financial performance, etc. The analyst then puts together a financial model that projects future earnings based on a set of assumptions. This financial model is used to estimate fair valuation of the stock price, which, when compared to the current trading level of the stock, leads to a recommendation of the analyst to buy, hold or sell the stock. (Alternative terms like "outperform," "market perform," and "underperform" convey similar beliefs of an analyst.)
The number of analysts covering a stock can vary widely. While blue chips or other well-known companies may be covered by several analysts, small companies that are relatively obscure may only be covered by one or two analysts. A company that is taken public by an investment bank will invariably have its stock covered by the brokerage arm of the investment bank to support trading of its equity in the markets and build an investor base for the shares.
Inherent Bias in a Covered Stock?
Smart investors appreciate the work of a sell-side analyst to bring forth facts and data pertinent to a company, but they often take with a grain of salt or ignore altogether a favorable recommendation by the analyst. First, it must be understood that it is extremely rare that an analyst attaches a "sell" or "avoid" or "underperform" rating on a stock. Almost all recommendations are "hold" or "buy" or analogous to these ratings. The reason is that an analyst needs access to management of the company to perform his or her work. The analyst must stay in the good graces of management to maintain flow of important information so that research reports can be written and sent to clients. Without the benefit of internal insight of a company, the usefulness of the analyst to the clients of the brokerage firm is in question. Therefore, the analyst feels pressure to slap on favorable stock recommendations, whether or not he or she truly believes them.