In the spirit of full disclosure from 1995 to 2004 I was an equity analyst, research manager and director of equity research at two different “boutique” brokers. My experience there, particularly with the last one at Adams Harkness in Boston (which was acquired by Canaccord Genuity), greatly informs my analysis with this type of business.
First of all from an industry point of view Sidoti is well known and often summarized as “a place that still covers tons of microcap stocks with research that is a mile wide and an inch deep.” There is basically one senior analyst, Peter Sidoti, and a squadron of relatively young analysts applying some basic research methods to small public companies.
Sidoti Stock coverage by industry last 180 days
Coverage is concentrated mostly in industrials and consumer discretionary with a decent amount of information technology as shown in the chart here covering research volume during the last 180 days.
There are a handful of terminal problems in the structure of the small brokerage business which I'll enumerate here. This isn't about the noble aims and hard work of the people involved – it's the structure.
Clients won't pay Sidoti more in commissions no matter what they do. They may hold on to what they have today but they will continue to run at $30M in revenues. They can add analysts, add coverage, upgrade their formats but clients will pay them the same amount. It might seem counterintuitive but it's the way it is.
Personnel costs eat up most of the potential for profit. In this case employee compensation and benefits is 73% of revenue. Everyone tries to keep this number down but the better research analysts, salesman and traders are, the more money they command. By going public Sidoti is trying to shift more of this compensation to equity which may then be perceived as worth something.
Other costs, even when tightly managed, consume the rest. In the case of Sidoti they generated $825K of net income for 2013. Since revenues won't grow and costs will be flat to up slightly this net income level more-or-less fixed.
One misstep on the trading side could easily eliminate a year of profit and even potentially sink the firm. It's happened more than a few times, often to small firms. We were working with one that disappeared overnight by getting a agency trade wrong – the resulting error costs exceeded their total equity.
Internet-based approaches like Seeking Alpha are beginning to make an actual dent in coverage of smaller capitalization companies. Quality is highly variable but there is a growing portion of “institutional quality” material being generated there that institutions are increasingly paying for.
