BETWEEN THE LINES
Tips on interpreting analyst reports, from our sell-side veteran.
Being a former sell-side analyst, I’m often asked for tips on how to best use and interpret research reports.
Institutional clients such as pension plans, mutual fund managers, family offices and investment counsellors generally have a good understanding of how to properly use equity research. Most of the problems I saw came from the investment adviser and stockbroker community improperly spinning sell-side research to secure new business and/or generate a new trade. For example, retail investors should realize they will never see a socalled hot deal or hot new issue from a stockbroker regardless of what a firm’s research report says. This is because capital markets divisions only relinquish the attractive four-to-five-per-cent upfront commission after their institutional clients take a pass.
Most brokers or advisers also won’t tell you their firms often restrict direct analyst access only to their institutional clients, so advisers are left just reading the published reports. Besides being able to contact the analyst for questions, institutional investors also receive all of the street’s research, whereas a broker will generally only have access to their own firm’s reports. That said, the do-it-yourself investor can act like a pro with a few easy steps.
Get access to as many different research sources as possible.
Make sure your broker or adviser is able to provide you with multiple research pieces from different firms in order for you to make as informed a decision as possible. This is very important since you are assuming the ultimate responsibility for the investment decision given that retail investment advisers in Canada currently have no fiduciary duty and, therefore, there is usually little recourse for accepting a poor recommendation.
See how many companies the analyst follows.
Always have a look at how many companies an analyst is currently covering. This is because an analyst covering too many companies may miss something. Ideally, look for those covering 10 to 15 companies. These analysts will also have more time to publish unique industry pieces with some tradeable ideas, including how to play M&A trends, implied commodity prices in valuations, potential industry threats and the companies impacted, irregularities in reporting, etc.
Read research from the firm that typically leads a company’s financings, but be careful.
There may be a bias because of the strong corporate finance relationship, but the research analyst covering the company will likely be on top of the story, in touch with management quite often, and know the ins and outs of the company. They may also be slower to react to bad news, choosing instead to give the company benefit of the doubt more so than others. Be cognizant of the potential conflict while taking advantage of the extensive information.
Look for outliers.
Most analysts will follow the general view with their target price and recommendation, otherwise they face what is known as career risk. This means those who are wrong more often than right will not last very long, so there is a strong incentive to stick to the mean. Be sure to read the research from those with conviction and perhaps even willing to stick their neck out a bit with a contrary call.
Ignore target prices
The biggest disappointment I had when I first started in equity research was in how target prices were determined. Look at indications in the reports for near-term catalysts and/or risks and whether these are factored into the company’s share price or not.