How Does Equity Research Work?

Equity Research Work

Investment has always been associated with carefully considered decisions, based on as much reliable information as possible. Nowadays, the investment process is especially multi-layered and versatile and there are more than ever variables that need to be taken into account. Therefore, various types of research are now employed by investors and financial analysts to determine the probable outcome and make the right call. One such type of analysis is known as equity research and occupies a very important place in the family of approaches to investment decision-making.

What is it and why does it matter?

Equity research is broadly defined as the study of a business, its industry, place in the market, and the broader environment in order to arrive at the decision regarding investing in its shares. Such a decision can then be made by the investment firm funding the research or it can be sold to some other interested party.

Thus, just like with all the other business analyses, the main goal of such research is to provide all the relevant facts needed to make the decision well informed. Without preparing such homework, investors would not be able to determine the best course of action and would be going on little more than a hunch.

Another important feature of equity research is that it helps to determine the reasonable price for the stocks and shares of interest. Having examined the business environment and presenting the results is also a great bargaining tool to bring down the price where possible.

Preparing the equity report

Turning now to how equity research works, to put it simply one can say that it all comes down to one thing – its end result. And this end result is usually presented in the form of a report with some common structural parts.

The report, prepared by the equity analysts will lay out the relevant information about the firm and provide comprehensive recommendations regarding the buying, selling, or holding of the shares. The report will usually have the following or similar structural parts.

  1. Industry research. The report will usually start with an overview of the market and industry environment in which the company operates. This will include the analysis of the competition, industry trends, major news, and innovations. The researchers will also look into technological developments or other signs of significant change that might shake up the industry landscape.
  2. Management overview. The second section of the report deals directly with the management of the company. Whatever other conditions are, the long-term success of the business depends highly on the competence and capability of the managing team. Thus, for the potential investors, it is crucial to understand how reliable in what they do the main decision-makers of a particular company are. Analysts have closer access to these teams and can ask them direct questions about the firm’s situation and prospects in order to review their abilities and understanding of the business. Providing the overview and commentary on the management team in the report helps the investors to adjust their expectations regarding the future of the firm.
  3. Historical financial data and results. Another important indicator of the company’s value is its historical results. Thus, equity analysts study the historical financial data of the firm and analyze its trends, shifts, and fluctuations. The key thing that the analysts will aim to do looking at this data is to compare the actual results with the market expectations. If the company has done worse or better than previously expected by financial analysts, it is important why it happened. Therefore, researchers will look at any key variables that could have caused the discrepancy between prognosis and reality.
  4. Forecasting. Based on the information laid out in the previous parts, in the fourth section of the report, the researchers will usually forecast the future revenue of the company. Here the equity analysts will project the future financial statement of the firm, for example, the next quarterly or semiannual report. There are two main approaches to such forecasting. The bottom-up approach will start with the lower-level data of the company, as the number of customers works its way up to the revenue. The top-down approach starts with the market data and projecting the market share of the company will finally arrive at the revenue. Choosing the right approach in the right circumstance is part of the job of the analyst.
  5.  Valuation. After forecasting comes the valuation of the company. Here is where based on the facts and assumptions researchers have arrived at thus far, they will determine the current value of the business. This is done by comparing it with other companies in the industry as well as taking note of the value of the previous similar transactions.
  6. Recommendations. Finally, it all comes down to what the equity researchers recommend to the investors. Thus, in the last part, the analysts will provide their conclusions regarding what is advisable to do with the company stock.

Keeping track of the news

Another important job of the equity researcher is staying on top of what is happening with the companies they are covering and their industries. Therefore, aside from the comprehensive reports, analysts will track all kinds of developments and major market events in order to inform their clients as soon as something important happens.

This is achieved by a constant overview of not only business and financial, but also political, economic, and social news that may influence the market. In fact, anything that can have an effect on the stock prices, from weather news to protests in a foreign country can become a part of equity research.

To stay informed analysts will also meet regularly, either in person or via video calls with the high-ranking representatives of the companies they cover. These meetings are regulated by various guidelines and rules of conduct to ensure that there is no unfair advantage in regard to the stock of public companies.

All such tasks of the analyst make equity research a crucial part of the investment procedure, ensuring that the decisions and fact-based and well-informed.