What's a 'Channel Check,' Anyway?

If you traffic in technology news or shares, you've undoubtedly heard about "channel checks." They are how analysts try to find out if Apple (or Adobe or Microsoft) are selling more or less of a given product than the market thinks. Basically, analysts go out and talk to people in the companies' supply chains and try to piece together what that means for the overall business. They're in the news today because, according to the Wall Street Journal, channel checks are one of the activities coming under SEC scrutiny.

So, what is a channel check? I did some years ago and here's how I think about them. If you're an investment analyst, you have a big spreadsheet. That spreadsheet tries to model how a company like Apple makes money. Everyone starts out with roughly the same information: how many iPads are selling at what profit margin, how many iPhones, how many Macs, etc., etc. Apple releases a lot of that information in their financial filings.

The real game, then, is predicting what those numbers are going to be in the next quarter or two. You want to know if Apple is going to sell more iPhones than everyone else thinks they're going to.

So, how could you figure that out? You can't actually ask anyone at Apple because that would be insider trading. But you can go out to the people who manufacture components for Apple products and ask them, "So, buddy, how many doodads that are needed for the iPhone 4 are you making this quarter? Is that more or less than expected?" You can also call up Best Buy middle managers and say, "So, how are iPod sales looking?" If you get enough of the right kinds of answers, you can start to make the bull or bear case for a stock.

It might not be the most elegant investing strategy, but if you've got a good (virtual) Rolodex, it can work. Is it insider trading? In most cases, probably not. It's just solid analysis.

But here's the tricky thing: if in the course of doing your channel checks at a hedge fund, say, you come across a bit of "material" information -- info that would be likely to impact a stock's price if it was widely known -- you can't trade on that inside information. However, sometimes it's hard to tell which bits of information are "material" and which are just "really awesome." That is to say, the very best channel check info comes right up to the materiality line without crossing it. The gray area is vast.

Alexis C. Madrigal

Alexis Madrigal is a senior editor at The Atlantic, where he oversees the Technology channel. He's the author of Powering the Dream: The History and Promise of Green Technology. More

The New York Observer calls Madrigal "for all intents and purposes, the perfect modern reporter." He co-founded Longshot magazine, a high-speed media experiment that garnered attention from The New York Times, The Wall Street Journal, and the BBC. While at Wired.com, he built Wired Science into one of the most popular blogs in the world. The site was nominated for best magazine blog by the MPA and best science Web site in the 2009 Webby Awards. He also co-founded Haiti ReWired, a groundbreaking community dedicated to the discussion of technology, infrastructure, and the future of Haiti.

He's spoken at Stanford, CalTech, Berkeley, SXSW, E3, and the National Renewable Energy Laboratory, and his writing was anthologized in Best Technology Writing 2010 (Yale University Press).

Madrigal is a visiting scholar at the University of California at Berkeley's Office for the History of Science and Technology. Born in Mexico City, he grew up in the exurbs north of Portland, Oregon, and now lives in Oakland.