Fundamentals of Equity Research

What is Equity Research?

In very simple terms, equity research is a study / analysis of equities or stocks for the purpose of investments. Equity research involves analyzing the fundamentals (financial statements, products, management, etc) of a company (stock) to derive the fair value for the company. Several big and small financial institutions, brokerage firms, etc produce research reports for the companies that are publicly traded or are listed on a stock exchange. A researcher aka Analyst covers companies (usually 8-12 stocks) which fall under the same industry (sector).

Working as an EquityAnalyst..

Typically equity analysts follow top down approach and begin their research by analyzing the key macro-economic factors, followed by understanding the overall industry drivers in which the company operates along with the company fundamentals to arrive at a fair value for the stock. In the midst of this, analyst may talk to management of the company to understand their perspective before taking a view on the stock of the company. Post this, analyst may take either a bullish or bearish view and sometimes may take a neutral view on the stock (if it is fairly valued at the current market price). However, such views are ever changing with economic developments (ex RBI rate cuts, Currency movement etc), company specific factors (ex quarterly results, news flow etc) and the share price evolution. Once an Analyst has built a view on the stock, he usually publishes a report which more often than not have 1) recommendation on the stock / industry, either buy, sell or hold and 2) investment thesis - reasons specifying his view on the stock / industry and 3) estimates / forecasts.

In nutshell, a typical equity research work can be break down into following segments

a) Marco Economic analysis

b) Industry analysis

c) Company analysis

d) Financial statement analysis

e) Modeling and Valuation

f) Report writing and Recommendations

Some of the most common valuation methods used in equity research include comparable multiples (PE, EVEBITDA, EV Sales), Discount Cash Flow (DCF) model, Dividend Discount Model (DDM) and Sum of the part analysis (SoTP).

Further, Equity Research business can be analyzed in three categories depending on the channels in which it is marketed:

• The  report / recommendationis sold to investors for a fee (Independent research houses)
• The report / recommendation is used for self consumption, that is to make an investment decision (buy-side research). Note - Buy-side researcher may not publish a full fledged report like sell side analyst
• The report / recommendation is sent out to customers, who would later generate  brokerage/ deal commissions for the firm (sell-side research). Such research houses are usually part of bigger firms who are into  investment banking, project finance, trading, etc

Carrying out the research analysis on stocks is just one part of the equity research analyst job, the other and perhaps the moreimportant one is marketing of these research analysis to different clients –both internal and external (fund managers, investors, traders, investment bankers, insurance houses, mutual funds, pension funds etc) and providing them new investment ideas and latest development in sector.

Some of the key skills which are required to be a successful analyst are:

• Very good understanding of accounting and financials
• Flair for writing the reports and investment thesis
• Ability to analyze the business and its pitfalls
• Sound understanding of financial modeling and excel