What is Equity Research?

Equity Research primarily means analyzing the company’s financials, performing ratio analysis, forecasting the financials in excel (financial modeling), and exploring scenarios to make a BUY/SELL stock investment recommendation. Equity Research analysts discuss their research and analysis in theirAn equity research report is a document prepared by equity research analysts or financial brokers that focuses on a specific stock, industry, currency, commodity, or fixed-income instrument, as well as a geographic region or country. It includes recommendations on why to buy or sell that stock, as well as DCF modeling, relative valuations, and so on.read more equity research reportsEquity Research ReportsAn equity research report is a document prepared by equity research analysts or financial brokers that focuses on a specific stock, industry, currency, commodity, or fixed-income instrument, as well as a geographic region or country. It includes recommendations on why to buy or sell that stock, as well as DCF modeling, relative valuations, and so on.read more.

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In this in-depth article on Equity Research, we discuss the nuts and bolts of Equity Research.

The equity Research explanation is quite simple. Let us look at these steps below.

  • Equity research is all about finding the valuation of a listed company (Listed companies trade on a stock exchangeStock ExchangeStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read more like NYSE or NASDAQ etc.Once you have the company under consideration, you look at the economic aspects like GDP, growth rates, the market size of the industry and the competition aspects, etc.Once you understand the economics behind the business, perform the financial statement analysis of the historical balance sheet, cash flows, and income statement to form an opinion on how the company did in the past.Based on management’s expectation, historical performances, and industry competition, project the financial statementsFinancial StatementsFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more like the BS, IS, and CFs.  (also called Financial Modeling in Equity Research)Use the Equity valuation models like DCFDCFDiscounted cash flow analysis is a method of analyzing the present value of a company, investment, or cash flow by adjusting future cash flows to the time value of money. This analysis assesses the present fair value of assets, projects, or companies by taking into account many factors such as inflation, risk, and cost of capital, as well as analyzing the company’s future performance.read more, Relative valuations, a sum of parts valuationSum Of Parts ValuationSum of the Parts Valuation is a valuation method wherein each of the subsidiary or segment of a Company is separately valued & then all of them are added together to estimate the business’s total value. read more.Calculate the Fair price based on the above models and compare the fair price with the Current Market Price (stock exchange)If the Fair Price < Current Market Price, the company stocks are overvaluedStocks Are OvervaluedOvervalued Stocks refer to stocks having more current market value than their real earning potential or the P/E Ratio. Overvaluation of stocks might occur due to illogical decision making or deterioration in a Company’s financial health. read more and should be recommended as a SELL.If the Fair Price > Current Market Price, the company shares are undervalued and should be recommended as a BUY.

Role of Equity Research

  • Equity Research plays a critical role in filling the information gap between the buyers and sellers of shares.All levels (individual or institutional) may not have the resources or capabilities to analyze every stock.Additionally, full information is not provided by the management, due to which further in-efficiencies are created and stocks trade below or above the fair valueEquity Research analystEquity Research AnalystAn equity research analyst is a qualified professional who interprets financial information and trends of an organization or industry to provide recommendations, opinions, reports, and projections on the corporate stocks to facilitate equity trading.read more spends a lot of time, energy, and expertise analyzing stocks, following the news, talking to the management, and estimating stock valuations.Also, equity research tries to identify the value stocksIdentify The Value StocksValue Stock is one that has the potential of selling at a higher price but due to the company’s adverse condition in the market, the stock is trading at a lower price than its actual worth based on its earnings, dividend, or sales.read more out of the massive ocean of stocks and help the buyers to generate profits.

What is the Typical hierarchy in Equity Research firms?

  • A typical hierarchy at an Equity Research firm starts with the Head of Equities/Head of Equities at the top.After that, there are Analysts (seniors) covering different sectors. Each analyst mostly covers around 10-15 companies in a specific sector.Each Senior analyst may be supported by an Associate, who a couple of Junior Analysts may support.

What is the role of the Head of Research?

  • The Head of Research acts as a key member to manage the Equity research analyst team, providing the team with leadership, coaching, and guidance to ensure that the brokerage goals and objectives are met.They oversee research reports, publications; it’s editing and monitoring the process of analysis and brokerage recommendations.They ensure that adequate support is provided to sales and trading teams.Contribute to Equities by providing expert-level inputs for overall strategy, goals, initiatives, and budgets.Responsible for Analyst hiring, compensation, development, and performance management.Liaison with fund managers and the research teams

What is the job of the Senior Analyst?

Below is an excerpt from a job requirement for a Senior analyst –

source – FederatedInvestor

  • Typically an equity research senior analyst would cover a sector with not more than 8-15 stocks. Coverage implies tracking these stocks actively. Senior Analyst tries to bring maximum companies under coverage in the sector they track (initiating the coverage)Many senior equity analysts cover companies that investors may want to invest in. These companies are like the high market capitalization companies or those with higher trading volume. There could also be cases where investors want to invest in small-cap or mid-cap stock companies with fewer analysts’ coverage.One of the most important responsibilities of a Senior Analyst is to develop a Quarterly Results Update – results from summary, expectation, and performance against those expectations, updating forecasts, etc.They talked to the clients (buy sideBuy SideThe term “buy-side” refers to entities that advise their clients like individual investors and institutional buyers on investments and securities purchases. Private equity firms, mutual fund companies, life insurance companies, unit trusts, hedge fund companies, and pension fund entities are examples of buy-side firms.read more) and showcased their calls on the stocks. They have to communicate buy-sell recommendations of stocks diligently. Additionally, they have to articulate clearly why a certain stock should be included in their portfolio.Write important industry event updates like conferences or management meeting updates.To update the Sales team, deal with the trading team about the latest news in the sector and the company, and keep them updated with the brokerage’s view.Attending conference calls for important company updates, results, etcAttend trade shows, meet company management, suppliers meetings, etc.

Responsibilities of an Associate

Below is the summary of the Associate job description from efinancialcareers

  • The primary job is to support the Senior Analyst in the best way possible.An associate has prior experience of around three years or so in a similar industry.Updating the financial model, verifying the data, and preparing the valuation models.Working on various client requests like a request for data, industry analysisIndustry AnalysisIndustry analysis refers to the analysis of industry’s environment that guides the industry to grow and survive in a competitive environment and gain a competitive edge in the industry as it predicts the future and changes in the market and analyze the threats and opportunities in the way ahead and making decisions and planning according to it.read more, etc.Prepare draft Equity Research Reports (update of results, events, etc.)Work on client requestsParticipate in meetings and calls with clients on the stock under coverage.

Responsibilities of a Junior Analyst

Here is a snapshot of the Junior Equity Analyst’s responsibilities.

source – careers.societegenerale.com

  • The main responsibilities of a Junior Analyst are to support the Associate in every format.The majority of the work done by Junior Analysts is related to data excel etc.Also, Junior Analysts may be involved in doing primary research, industry research, coordinating with clients, etc.We maintain the industry database, charts, graphs, financial models, etc.

Typical Day at an Equity Research Firm

Previously, I had worked with companies like JPMorgan and CLSA India as an Equity Research Analyst. I covered Indian Oil & Gas sectors with stocks like ONGC, BPCL, HPCL, GAIL, etc.  Below was my typi.cal day as an Equity Research Analyst.

7:00 am – Reach office

  • Check emails from traders and salespeople.Check the stock markets (Asian Markets that open first)Check for all the news related to your sector.

7:30 am – 8:00 am Attend Morning Meeting

  • A morning meeting is nothing but a formal discussion of the recommendations before the market opens, along with the Sales & Trading Team.In this morning meeting, all analysts present their views on key developments in their sector, along with the Head of Research or Equities presenting their views on the general markets.

9:00 am – Market Opens

  • Follow the Market, look for key developments in your sectorTry to rationalize if there are any rapid stock price movements

10:00 am – Regular Work

  • Perform regular research analyst duties like Client Requests, Financial Model updates,Follow the News and keep a close check

11:00 am – Regular Work / Client Discussions

  • Discussion with buy-side clients for any explanation of research/callsContinue doing your regular maintenance work

3:30 pm – Market Closes

  • Capture the market movements of the company under coverage for the day closure.Check if there is anything that the clients should know and work accordingly.

4:00 pm – Work on New Research Publications

  • Work on the new research piece for publication (next day or in the coming days)Generally, a research analyst targets at least 1 to 2 research pieces every week.

7:30-8:00 – go Home

  • If there is no earning seasonEarning SeasonThe Earnings season refers to the quarterly report of companies’ results, such as revenue/profits, released in the first two weeks after each quarter ends (Dec, Mar, Jun, Sep). It helps investors in making investment decisions and determining the value of their investments.read more (company results), the typical go-home time is 7:30-8:00 pm. However, there is no surety when you will reach home during earning seasons.You need to prepare the result update report fully and keep it ready for the next day’s early morning publication.

Who Pays for Equity Research?

  • Independent Equity Research firms: Independent equity research firmsEquity Research FirmsThe list of top 10 equity research firms in the world comprise: JP Morgan Chases and Co, Bank of America Merrill Lynch, Credit Suisse, Barclays Capital, Citigroup, Goldman Sachs, Morgan Stanley, AllianceBernstein L.P.,UBS, and Nomura Holding Inc.read more do not have a trading and sales divisionTrading And Sales DivisionOne of the main functions of an investment bank in the country is sales and trading, in which the investment banking sales team pitches clients for trading ideas and the traders team executes activities related to the purchase and sale of securities and other financial instruments in the market for itself or on behalf of its clients.read more. They perform financial analysis with the idea of charging fees on a per report basis. Also, see Equity Research vs. Sales and TradingEquity Research Vs. Sales And TradingEquity research involves conducting a thorough stock analysis, which includes financial modeling and valuation, as well as a review of financial statements, which is crucial in determining if a particular stock is a suitable investment or not. Sales and trading analysts are in responsible for marketing securities to their clients and delivering timely and relevant information that allows them to make informed decisions.read more.For Major Equity Research firms: Fee income is earned by brokerage trades (Soft Dollars). To understand this in detail, let us look at the diagram below –

  • As noted above, on one side are the Buy Side firms like Hedge FundsHedge FundsA hedge fund is an aggressively invested portfolio made through pooling of various investors and institutional investor’s fund. It supports various assets providing high returns in exchange for higher risk through multiple risk management and hedging techniques.read more, Pension Funds, Insurance Companies, Mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more, etc.On the other side are the sell-side firms like JPMorgan, Goldman Sacks, Credit Suisse, etc.The buy-side firms manage the portfolio, and they are required to invest their portfolio as per the investment objective.Investment objectives may mandate these companies to keep a portion of their assets in Stocks etc.In such cases, the buy-side analysts seek advice from the sell-side analyst for investment decisions.The advice or the idea provided by the sell-side analyst is literally for FREE. Once the buy-side analyst has decided to invest in the stock, the buy-side analyst may look forward to executing the trade through the Trading division of the sell-side firm.The trading division will, in turn, charge a commission for executing the trade at the lowest price.The commission, in return, is the earnings of the research firms.

Equity Research Professional Approach

So what is your work like as an Equity Research Professional? Equity Research analysts follow stocks and recommend whether to buy, sell, or hold those securities usingFundamental Analysis (FA) refers to the process of studying any security’s intrinsic value with the object of making profits while trading in it. The primary purpose of fundamental analysis is to determine whether the security or stock is undervalued or overvalued and thereby make an informed decision to buy, hold, or sell it in order to maximize the potential for gains.read more Fundamental AnalysisFundamental AnalysisFundamental Analysis (FA) refers to the process of studying any security’s intrinsic value with the object of making profits while trading in it. The primary purpose of fundamental analysis is to determine whether the security or stock is undervalued or overvalued and thereby make an informed decision to buy, hold, or sell it in order to maximize the potential for gains.read more. Equity Research is a very challenging job, where an analyst may be required to spend more than 12-14 hours a day.

For creating a professional Equity Research Financial model, an expert analyst’s recommended approach is as follows –

Economic Analysis / Industry Analysis / Company Analysis

  • The first thing you need to take care of while doing a professional analysis is learning about the economic parameters affecting the industry, the industry dynamics, competitors, etc.For example, you should know about every subdivision of AlibabaAlibabaAlibaba is the most profitable Chinese e-commerce company and its IPO is a big deal due to its size. With its huge size and network, Alibaba IPO may look at international expansion beyond China and may lead to price wars and intensive competition in the US.read more and its competitors when analyzing Alibaba.

Fundamental Analysis

  • You should be awesome at Fundamental Analysis. Fundamental Analysis means performing a Ratio Analysis of the company under consideration.Before starting ratio analysis, you should populate at least the last five years of financial statements (Income Statement, Balance Sheet, andCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more Cash FlowsCash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more) in excel.You should prepare a blank excel sheet with a Separate Income StatementIncome StatementThe income statement is one of the company’s financial reports that summarizes all of the company’s revenues and expenses over time in order to determine the company’s profit or loss and measure its business activity over time based on user requirements.read more, Balance Sheet, and Cash Flows and use neat formats.Populate the historical financial statements (IS, BS, CF) and make the necessary adjustment forNon-recurring items are income statement entries that are unusual and unexpected during regular business operations; examples include profits or losses from sale of asset, impairment costs, restructuring costs, and losses in lawsuits, and inventory write-off.read more Non-recurring itemsNon-recurring ItemsNon-recurring items are income statement entries that are unusual and unexpected during regular business operations; examples include profits or losses from sale of asset, impairment costs, restructuring costs, and losses in lawsuits, and inventory write-off.read more (one time expenses or gains).Do the Ratio AnalysisRatio AnalysisRatio analysis is the quantitative interpretation of the company’s financial performance. It provides valuable information about the organization’s profitability, solvency, operational efficiency and liquidity positions as represented by the financial statements.read more for Historical yearsAn example is presented below in Colgate Ratio Analysis

Preparing a Professional Financial Model

  • Company management does not provide the future financial projectionsFinancial ProjectionsFinancial projection is a statistical forecast of a company’s future revenue and expenditure based on historical market patterns, internal factors, data interpretation, anticipated market developments, and experiences. To meet production or sales targets, both short-term and long-term financial estimates are sometimes evaluated.read more of the company. Therefore, a research analyst needs to project this data. Forecasting the financials of the company is known as Financial Modeling. I earlier wrote a 6000-word step-by-step tutorial on Financial Modeling. If you want to master Financial Modeling, you can refer to this Financial Modeling Tutorial.

Valuations – DCF

  • Valuation is primarily done using – a) Discounted Cash flowDiscounted Cash FlowDiscounted cash flow analysis is a method of analyzing the present value of a company, investment, or cash flow by adjusting future cash flows to the time value of money. This analysis assesses the present fair value of assets, projects, or companies by taking into account many factors such as inflation, risk, and cost of capital, as well as analyzing the company’s future performance.read more and b)Relative Valuations.Once your financial model is ready, you can perform Discounted cash flows as given in the steps below –Calculate FCFFCalculate FCFFFCFF (Free cash flow to firm), or unleveled cash flow, is the cash remaining after depreciation, taxes, and other investment costs are paid from the revenue. It represents the amount of cash flow available to all the funding holders – debt holders, stockholders, preferred stockholders or bondholders.read more as discussed in class and the handbookApply a suitable + [Cost of Debt * % of Debt * (1-Tax Rate)]” url=”https://www.wallstreetmojo.com/weighted-average-cost-capital-wacc/”]WACC”WACC””The post the calculation of the capital structure.Find the Enterprise Value of the Firm (including the Terminal ValueTerminal ValueTerminal Value is the value of a project at a stage beyond which it’s present value cannot be calculated. This value is the permanent value from there onwards. read more)Find Equity ValueEquity ValueEquity Value, also known as market capitalization, is the sum-total of the values the shareholders have made available for the business and can be calculated by multiplying the market value per share by the total number of shares outstanding.read more of the Firm after the deduction of Net Debt.Divide the Firm’s Equity Value by the total number of shares to arrive at the “Intrinsic Fair Value” of the company.Recommend whether to “BUY” or “SELL”

Valuation – Relative Valuations

  • Relative valuation is based on comparing the company’s valuation under consideration with the valuation of other firms. Valuation multiples are used to value companies like The price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. read morePE MultiplePE MultipleThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. read more, EV/EBITDAEV/EBITDAEV to EBITDA is the ratio between enterprise value and earnings before interest, taxes, depreciation, and amortization that helps the investor in the valuation of the company at a very subtle level by allowing the investor to compare a specific company to the peer company in the industry as a whole, or other comparative industries.read more, PBV ratioPBV RatioPrice to Book Value Ratio or P/B Ratio helps to identify stock opportunities in Financial companies, especially banks, and is used with other valuation tools like PE Ratio, PCF, EV/EBITDA. Price to Book Value Ratio = Price Per Share / Book Value Per Share
  • read more, etc.

The common approach is given below.

  • Identify the comparable based on the business, Market CapitalizationMarket CapitalizationMarket capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share.read more, and other filters.Identify a suitable trading valuation multiple to be used for this business.Use the average valuation multiple to find the valuation of the company.Suggest “Undervalued” or “Over-valued.”

Research Report

  • Once you have prepared the financial modeling and found the fair valuation of the company, you need to communicate this to your clients through Research Reports. This research report is very professional and is prepared with a lot of caution.Below is a sample of the Equity Research Report. You may learn about Equity Research Report Writing here.https://www.wallstreetmojo.com/wp-content/uploads/2015/03/Reliance-Petroleum.pdf

Equity Research Skills-Set

 Here are excerpts from the Equity Research Job Requirements Description –

Key highlights to note from this excerpt is –

  • MBA is a plus (not a necessity). If you are an MBA, you have certain advantages, but if you are a graduate, you should not get disheartened. You have a chance if you prove your interest in finance. Please look at Can an engineer get into an Investment Bank?Financial discipline is not essential, but you must have a strong interest in the financial marketsFinancial MarketsThe term “financial market” refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces.read more with excellent quantitative and analytical skills.You should be fluent in English and have excellent verbal and written communication skills.You possess intellectual curiosity, focus, and creativity and have a keen research instinct with creative problem-solving abilities.Strong proficiency in Microsoft Excel and PowerpointCFA designation – This is one important designation that the finance industry respects. Try to ensure that you take the CFA examinationCFA ExaminationThe Chartered Financial Analyst (CFA®) Program offers a graduate-level curriculum and examination program designed to expand your working knowledge and practical skills related to investment decision-making. read more and pass at least a couple of levels.I wrote a detailed post on the skills required to enter Equity Research. My top 5 skill sets required to enter the Equity Research Industry are –

  • Excel SkillsFinancial ModelingValuationsAccountingReport Writing

You can get an in-depth understanding of the skillsets here – Equity Research Skills.

Top Equity Research Firms

Institutional Investors ranking suggests that in 2014, the best research firm was Merril Lynch Bank of America, second place was taken by JPMorgan, and Morgan Stanley came third.

Apart from the top 3 above, there are other notable equity research firms (listed below)

Equity Research Compensation

  • Junior Analyst/Assistants have a base comp of $45,000 – $50,000 per year (average)Associates have a base salary of $65,000 – $90,000 per year (average) depending on the experience. Additionally, they get a bonus of 50-100% of the base salary (in an average to good year)Senior Analysts generally have a base compensation of $125,000 – $250,000. Their bonus may range from 2-5 times the base compensation.

Equity Research Exit Opportunities

Sell-Side research analyst has various Career Opportunities –

Within Equity Research Firm

  • If you join as an associate, you can move up the ladder to become a Senior analyst assuming full responsibility for the sector coverage.Later you can move further up to become Head of Research and Head of Equities.

Private Equity Analyst

  • Sell side analysts also move to the Private Equity domain working as Private Equity AnalystPrivate Equity AnalystA private equity analyst is an analyst who looks for undervalued companies for a private equity investor to buy, take them private and earn profits. The companies are primarily unlisted, and the risk is higher.read more.Instead of analyzing public companies, they analyze private companies from the point of view of investments.They can move up the hierarchy to become a Private Equity Fund manager. Check out the list of Top Private Equity FirmsTop Private Equity FirmsPrivate equity firms are investment managers who invest in many corporations’ private equities using various strategies such as leveraged buyouts, growth capital, and venture capital. The top private equity firms include Apollo Global Management LLC, Blackstone Group LP, Carlyle Group, and KKR & Company LP.read more.

Investment Banking Analysts

  • The movement of sell-side analysts toInvestment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc.read more Investment bankingInvestment BankingInvestment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc.read more is slightly tough but not impossible.Sell side analysts are fully aware of financial research and modeling-related work.They haven’t worked on transaction-related work like IPO filing documents, Pitch booksPitch BooksPitch Book is an information layout or presentation used by investment banks, business brokers, corporate firms, and others to provide potential investors with the firm’s main attributes and valuation analysis, which helps them decide whether or not to invest in the client’s business. A pitch book is also known as Confidential Information Memorandum, which is used by the firm’s sales department to help them sell products and services to a client.read more, registration work, etc. If you are confused between Investment Banking and Equity Research, read this article – Investment Banking vs. Equity ResearchInvestment Banking Vs. Equity ResearchEquity research is a mechanism through which an organization’s financial well-being, i.e. assets and liabilities are analyzed, which further helps investors make investing decisions. In contrast, investment banking is a banking function that offers financial services to individuals and companies and enables them to raise capital.read more.

Buy Side Firms

  • Sell side analysts sometimes are also absorbed as buy side analysts (working for Mutual funds, etc.).The buy side analysts assume the responsibility of fund managers over some time.

Corporate Finance

  • Equity Research Interview Questions

Conclusion

Equity Research means preparing an estimate of the company’s fair valuation to recommend the buy-side clients. The equity research job rewards analysts with relatively higher compensation, but it also provides excellent exit opportunities. Though, as a research analyst, you may spend 12-16 hours a day at the office; however, this is a dream job for many who love Finance and Financial Analysis. If you like to work in a challenging and dynamic environment, then this is one career you must consider.

Equity Research Video

What next?

Happy Learning! If you learned something new or enjoyed the post, please comment below. Let me know what you think. Many thanks, and take care.