Equity
research is a part of investment banking sector in nature. It’s a part of
intellectual and quantitative calculations and analysis.
Equity
research primarily means analyzing company’s financials, perform ratio analysis,
forecast the financials (financial modeling) and explore scenarios with an
objective of making BUY/SELL stock investment recommendation. Equity research analyst
discuss their research and analysis in their equity research reports (ER
Reports).
Looking
into the table, it is clear that ER is all about making valuation
of listed companies (i.e whose shares
are listed/traded in stock exchanges).
First thing to consider is, which company’s stock we are looking to BUY or
SELL?
Once we are done with the selection of company under consideration, we should
consider the macro-economic aspects like Economic growth rates, GDP, market size
and effect of inflations/interest rates over there.
With the economic factors and aspects behind the business in
which the company is operating, it should move forward for the analysis of
financial statements. To start with, we have to analyze the historical
financial statements including significant disclosures and contingent aspects,
which will help us to build up a opinion regarding past performances, financial
positions and cash flow operating cycle. during fundamental analysis, we should
include precise and relevant information, reason is that a slight change in numerator
or denominator may impact a huge change in historical financial ratios. For example,
we should investigate the terms like shareholders fund, restricted
funds, regulatory funds/liability, funds collected and fund used, non-cash
items, tax expenses etc.
Now, based
on management’s expectations, visions & missions, new expansions under
consideration, market reactions, historical records and trends, industry
competition, correlation with the industry movement, regression analysis, we need to prepare a projected financial statements/informations like Balance
sheet, Income statement, cash flows, funds flows, of the company. And is called
by “financial modeling” under ER.
Don’t
be so confused with financial engineering and financial modeling at this step, because
both of the intelligence has different scopes, objectives, methods and users. financial
modeling is the core process of ER, result of which determine most of the investment
decisions. Now, while using it, there are different valuation approaches and models
with few limitation and strengths. But the thing we have to consider is the relevancy
and reliability of inputs and assumptions used for the inputs.
For
example, when we are using discounted cash flow model, the major thing we have look carefully is, calculation of discount rates and estimation of cash flows over the
period under consideration and risk factors. after all, the reliability of output will depend on the
source and methods used to calculate the inputs.
At
last but not the least, it’s up to the researcher for comparison of fair value data result of financial modeling with market data and to make a decision on BUY,
HOLD or SELL.
-Rohit Dhital,
Chartered Accountant
rohit.dhital@gmail.com
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