HOW TO READ EQUITY RESEARCH REPORT

If you have been in the stock markets for some time, you have likely seen one of those glossy equity research reports either of companies or of industries. The idea of an equity research report is to give a view and a justification on why a particular stock is attractive from an investment perspective. An equity research report typically has an action point in that it gives a view as to whether they believe the stock will outperform or underperform vis-à-vis the market index overall.

Today, the typical equity research report has become largely digital but the idea remains the same. The typical equity research report will give the background of the company, the valuation metrics, details on the valuation model, industry and macro analysis, detailed company financial analysis, the outlook for the industry and company, etc. Let us quickly look at how to go about reading an equity research report on India.

HOW TO READ EQUITY RESEARCH REPORT

In this world of information overload, there is no shortage of data, information, and news flows. What is missing is the ability to translate all these data points into an actionable insight on stocks. That is where an equity research report comes in handy. Remember, that an equity research report does not give a recommendation but it only gives a view. Normally, brokers prepare equity research reports for the benefit of large institutional clients like FIIs, pension funds, mutual funds, PMS schemes, and insurances. However, brokers also make equity research report for high net worth investors and wealthy clients.

So, if you think that there is a mountain of information about companies floating around in annual reports, business newspapers, television, and the internet, just think again. Another important source is an equity research report written by analysts who are established and respected experts in this field. Typically, the equity research report is written by analysis with sector expertise and has long experience interfacing with the senior management of companies in that particular sector. That is what adds credibility to the equity research report.

How should you go about reading an equity research report?

That is the million-dollar question. The job of an equity research report is to analyze a particular company’s financials, ratios, and product and business characteristics in detail. It entails an elaborate ROE analysis, comparing with a peer group, forecasting the financials, projection of cash flows, deciding on the cost of capital of valuation, etc. Let us now look at how you must read each of the sections of the equity research report with a specific focus on what each of these sections contains.

• The first major set of information contained in an equity research report is the basic information about the company, its traded stocks, price and volumes, Bloomberg Code, market cap, free-float market cap, etc. The basic section of the equity research report also gives a picture of liquidity, major shareholdings, recent developments, and a forecast of earnings. Typically, the equity research report begins with an executive summary that justifies the view on the stock.
• The second key section of the equity research report covers an elaborate description of the company business, the industry it operates in, its products and services, a note on the technology, etc. It does the equivalent of a SWOT analysis of the product or what you can call a 5-factor Porter Analysis of the key drivers of revenues and expenses as well as future value drivers. Many of this data is available through the company filings, industry association, peer group, channel checks, etc.
• In the last few years, it is management quality and standard of corporate governance, that is acquiring a lot of importance in an equity research report. This includes a detailed analysis of the company’s quality of management, compensation policies, the role of the various audit committees, capital allocation, incentive plans, and levels of stock ownership. This section also evaluates important points like succession planning, the composition of the company’s board of directors, and the role of independent directors in managing and controlling the risk of the firm. This is a segment of the equity research report that you must spend sufficient time on.
• Now we get down to brass tacks. You cannot judge the company without understanding the industry it operates in, the industry overview, and competitive positioning. This section of the equity research report also covers finer points like product obsolescence, risk of disruption in the industry, potential product and process threats, etc. Additionally, production capacity levels and pricing, distribution, and stability of market share are shown. This section of the equity research report focuses a lot on the environment that which the particular business operates.
• Now comes the cream of the equity research report or what we call the financial analysis. This is the stepping stone to cash flow projections and valuations. Here a detailed study of the financials is done on an annualized basis and quarterly basis to get an idea of growth trends. The focus here is on identifying financial growth parameters that can drive valuations.
• The next part of the equity research report contains a thorough valuation analysis of the company using conventional valuation metrics. Most companies use the highly formidable discounted cash flow or DCF model for valuing companies. However, that is not all. Equity valuation models can derive either absolute or relative values. Also, a detailed analysis of the company’s historical financial performance and a forecast of future performance is included. In a typical equity research report, projection of financials goes much beyond just extrapolation. This forms the basis for base case valuation in an equity research report.
• There is no business without risk, so this critical segment focuses on the risk factors like negative industry and company developments that could pose a risk to the investment decision. It also looks at other hurdles like operational or financial risk or related to regulatory issues, corporate governance, or legal proceedings.
• Finally, we come to the deliverable, Based on the financial analysis, projections, valuations, and review of intangibles, the output is whether the stock could be an outperformer or an underperformer. The final decision on how to act on the equity research report is left to how the sales team interfaces with the client.

The next time you see an equity research report, remember these are the key points to focus on.

WHAT ARE FUNDAMENTAL REPORTS

Fundamental Research Reports as the name suggests are based on fundamental parameters like company financials, intrinsic value, etc. It evaluates a company based on several financial, economic, qualitative, and quantitative parameters with the end objective of arriving at an intrinsic value for the company. The fundamental report is normally based on a very elaborate and rigorous process. The fundamentals of a company are evaluated only after the preparatory job of initial screening.

The typical fundamental report of a company will include, inter alia, the financial reports of the company, the ROE analysis, the solvency, profitability and leverage ratios, the company’s products, competitors, management, and corporate governance. It also includes other factors like the price-earnings ratio or the P/E ratio, price to book or the P/BV ratio, Profit and loss statements, Cash-flow statements, the balance sheet of the company, and its prospects in the industry environment.

WHAT IS EQUITY ADVISORY

Equity Advisory is essentially a mid to Long term equity market investor-oriented service that believes in and essentially adopts a disciplined investment approach. The focus is more on managing risk rather than on just enhancing returns. The idea of equity advisory is to customize the equity portfolio to the unique needs of the client. In the realm of PMS services, equity advisory is non-discretionary so it keeps the client in complete control of stocks and funds, restricting the activity to purely offering high quality and value-added equity advisory services.

Equity Advisory helps investors in obtaining a very unique proposition that comprises focused research, risk profiling, style-based investing, management of the risk of the portfolio at an overall level, relative weightage among stocks & sectors, relative performance benchmarking with indices, time of entry, and impact of volatility, etc.

In short equity, an advisory is nothing but research-backed investment advice. It focuses on the design and creation of a diversified portfolio which is specifically created as per the risk profile and the requirements matrix of the client. Normally, equity advisory is from a medium to long-term perspective with a time frame of 3-5 years. The idea is to design and execute tailor-made portfolios and additionally adopt a highly disciplined investment approach based on research and broad-based asset allocation.