.Introduction
Equity Research of listed stocks forms a major part of operations in Hedge Funds, Investment Banks, and many Asset Management firms.
Analysts use different methods to conduct equity research, but they primarily aim to determine a stock’s intrinsic value and assess whether it is overvalued or undervalued. Based on this analysis, they issue buy, sell, or hold recommendations to asset managers or their clients.
What makes an equity research exercise comprehensive?
Though equity research exercise could potentially be a theoretical exercise where an Equity Research analyst puts in a few hours’ of efforts, crunch numbers, and comes up with a recommendation. Analysts almost always prepare these models and simply feed in the P&L, Balance Sheet, and Cash Flow numbers—readily available in the public domain for listed stocks—to determine the valuation and recommendation for the stock.
It is however the further details that determine the quality of the research. These are a variety of sources, qualitative inputs and their quantification, Evaluation of the ongoing news and buzz related to the stock, social media activity, rumors, and the subjective calls of analyst that makes the difference. It’s amazing that some analysts even track the brand of the watch that the CEO wears to the analyst conferences. They make subjective calls on the stock on an information point as minute as that or say body language of the management in a conference call.
If a stock is to watched as closely as needed to take calls worth millions, it’s not possible for an equity research analyst to proceed in a templated way for all the stocks she needs to track. It needs to go much beyond that.
Parts of a comprehensive Equity Research exercise
Here is what differentiates a comprehensive analysis from a basic one
Sources of Information: Sources of information if more the merrier. Sources of information if diverse allows us to analyze the stock closely. For example, a database that carries information about all the legal cases pending against a company would add color to the analysis that will have a material impact on the overall recommendation for the stock. Usual sources of information are P&L, Balance sheet, and cash flow statements, all of which are publicly available for a listed stock apart from news about the stock, regulatory filings, 10Ks, conference calls, and ESG related compliance documents.
Forecast and Assumptions: A financial forecast is often oversimplified by merely projecting past growth into the future, but that approach is rarely accurate. The core of any robust forecast lies in its assumptions, which must be reasonable and ideally validated by industry experts. Companies may be optimistic about new strategies, but such expectations should be evaluated against industry benchmarks. If a company’s forecast outpaces industry projections, one must examine whether it has outperformed the industry before. For example, if a healthcare firm claims it will lead the market in five years, has it achieved similar milestones in the past? The strength of any financial model depends on the depth and validity of its assumptions—verified by data and historical performance.
Company Valuation Analysis
Equity Quantitative Research focuses on valuing a company using multiple methods to ensure consistency across different approaches. When there’s a significant difference in valuations, the analyst must determine the most suitable value with strong justification. Analysts commonly apply valuation models such as Discounted Cash Flow (DCF) to project future cash flows and discount them to present value. They use Relative Valuation to benchmark the company against its peers and determine whether it’s undervalued or overvalued. They also employ the Sum of the Parts method to break down a diversified business into individual components and evaluate each separately. Risk Assessment is also critical—it identifies potential risks and quantifies their impact on the company’s valuation. Together, these methods help analysts build a more balanced and defensible view of a company’s worth.
Qualitative Assessment
Numbers do tell the story but miss while indicating the future, which is unknown. That is where the qualitative inputs come into play. An experienced analyst can convert these qualitative inputs into quantitative ones that impact the valuation. Some of these qualitative inputs are quality of management, Competitive intensity in the industry, ESG initiatives and risks, and analyzing Porter’s 5 forces. It’s to be noted that Porter’s 5 forces is a highly qualitative model and needs to be put on a quantification scale.
Different institutions approach equity research differently depending on their business and operational needs. Here is how Equity Research differs across institutions
Equity Research for Investment Banks
Equity Research at Investment Banks is as much as a Marketing exercise as it is operational. Usually, an Investment Bank would send stock recommendations to all its current and potential clients. Analysts sometimes avoid detailing these recommendations, as they reserve in-depth research for high-paying clients. They prepare an equity research report for every stock, using a template with similar content across all stocks the bank tracks. It also suggests the buy, sell, or hold recommendations along with the price range to expect for each stock. Detailed equity research is also done for the buy-side. There are multiple research report templates that are available with an Investment Bank.
Earlier the research cost was added to the brokerage cost for an investment bank. Now a regulatory notification in Europe bars Investment Banks from clubbing brokerage and research costs together. This means now research needs to be high quality and needs to be provided only when the client demands. It’s just a matter of time that these regulations catch hold in the United States and other financial markets across the world.
Equity Research for Hedge Funds
Equity Research for hedge funds is done towards the aim of portfolio management and taking long and short positions regarding listed stocks
Hedge Funds are quite secretive about the methodology they follow while picking up stocks. Sometimes firms justify secrecy. As they truly have something unique, but most of the time they use it as a marketing gimmick to avoid further questions about their methodology. Many claim to use Machine Learning and Artificial Intelligence to pick up the stocks. Equity Research in Hedge Fund parlance is the most critical part of Operations. There is also a huge reliance on Technology with trades mostly intraday and sometimes in milliseconds!! But there is nothing that has replaced the good old fundamental analysis.
Hedge Funds also specialize in technical analysis apart from fundamental analysis. Technical analysis uses mathematical formulas to project trends and thus the future stock price for short term trades.
Equity Research for Private Equity
Private Equity usually deals in Private stocks but sometimes they do pick up stake in listed companies as well. Private Equity firms conduct equity research differently from Hedge Funds and Investment Banks. They usually aim to buy a significant stake and therefore access much more information and management bandwidth. It uses that leverage to get and analyze information that is usually not available in the public domain.
Equity Research for Asset Managers
All other forms of Equity Research vary in complexity and methodology. But mostly sticking to finding the intrinsic value of the stock with the aim of finding undervalued stocks for investments. Some Asset Managers specifically perform equity research for retail investors.
Magistral’s Approach for Equity Research
Magistral is an equity research firm that focuses on Fundamental Research to find out the intrinsic value of a stock using multiple sources. We start with multiple sources in our methodology and continually refresh those sources to update the model with the latest intelligence. We also prepare customized Equity Research report. Here is how our Equity Research Process looks like
Magistral’s Equity Research Methodology
Our equity research services are customizable and scalable as per clients’ requirements. Magistral has delivered multiple Equity Research projects in the past
About Magistral
Magistral Consulting has helped multiple funds and companies in outsourcing operations activities. It has service offerings for Private Equity, Venture Capital, Family Offices, Investment Banks, Asset Managers, Hedge Funds, Financial Consultants, Real Estate, REITs, RE funds, Corporates and Portfolio companies. Its functional expertise is around Deal origination, Deal Execution, Due Diligence, Financial Modeling, Portfolio Management and Equity Research
For setting up an appointment with a Magistral representative visit www.magistralconsulting.com/contact
About the Author
The Author, Prabhash Choudhary is the CEO of Magistral Consulting and can be reached at Prabhash.choudhary@magistralconsutling.com for any queries or business inquiries.