While technical skill and depth of research are highly important for an equity analyst, many good analysts fail to live up to their potential because they don’t present their work in the best light.
James Valentine, author of “Best Practices for Equity Analysts” illustrates the importance of communication using the chart below. As an analyst you want to make sure your research is consistently falling into the top right quadrant.
Fortunately, there are a few simple guidelines that you can apply to ensure your research generates the maximum impact. Following these rules will also help you to organize your thoughts, question your own thinking and ultimately make you a better analyst.
State your Thesis
An equity research note should be written with the customer in mind (usually a portfolio manager). That PM is looking for an answer to the fundamental question “should I be long or short this stock”? They want a clear conclusion and a well-reasoned thesis to back up that conclusion. And in order to be valuable to a PM, that thesis needs to go beyond what is already well understood by the market.
You should start by distilling your thesis down to 3-4 bullet points. Each bullet point should focus on where your view is different to the market. An example of an investment thesis might be as follows:
- Revenue growth to exceed expectations. I expect revenue growth of 5% CAGR over the next five years, versus consensus expectations of flat growth.
- Concerns over lawsuit overstated. The stock has been oversold on the uncertainty over the recent lawsuit. My analysis shows that the eventual impact is likely to be modest.
- Valuation. My valuation, based on a DCF, generates a price target of GBP 45, offering 25% upside to the current price.
Each of these bullet points can be turned into paragraph and this will form the first section of your note, the “Investment Thesis”. The Investment Thesis is like the trailer for the rest of the movie – it indicates to the PM what your core message is and why they should read on.
It can’t be stressed enough that the PM is looking for an edge in the market – an insight or inference that is not already common knowledge in the market. Your investment thesis, therefore, needs to indicate where your view is different to that of the market.
Build the Structure
Once you have established your investment thesis, then structuring your note is easy. The structure should simply follow the outline laid out in your thesis. This ensures that your note remains conclusion-oriented and concise. You won’t end up writing pages of analysis on matters that don’t impact the outcome and that the PM is unlikely to have any interest in.
This doesn’t mean that you aren’t doing thorough research on every aspect of the company. This research is absolutely necessary in order to generate your unique insights and your conclusion. But what you share with the PM should focus primarily on what is unique about your view. Many inexperienced analysts don’t understand that this is the purpose of a research note, instead viewing it as vehicle to demonstrate their knowledge of a company. You should avoid making this mistake.
Other sections such as a company description, the risk section and the valuation section can be built around the thesis. Using the example outlined in section 1, the structure would then look like this:
- Investment Thesis (1 page max)
- Company Description (1 page max)
- Revenue growth to exceed expectations
- Concerns over lawsuit overstated
- Valuation offers 25% upside
- Risks to Investment Thesis
Identify the Key Drivers
Top analysts understand that there are thousands of variables and drivers that impact the value of a stock, but only a few that really matter. These analysts are able to identify and isolate key drivers and focus the bulk of their analysis on the study of those drivers.
“The most distinguishing element of great analysts is that they put a disproportionate amount of time into forecasting only a few of the factors likely to move their stocks” James Valentine, Best Practices for Equity Research Analysts
It is usually the case that your understanding of these key drivers corresponds to your unique insights. This is why these key drivers will almost always feature heavily in your investment thesis. In the case of our theoretical investment case from Section 1, the key driver behind revenue growth might be any number of things – the pace of annual price hikes, the growth rate of an emerging market business or penetration of a developed market. Whatever the key driver, make sure to focus most of your attention here.
The key drivers will usually play a critical role in generating your forecasts (see next section). It’s important to fully explain your assumptions as they relate to your key drivers, particularly where these assumptions differ from the market. This is the “secret sauce” at the heart of your research, and your ability to convince a PM of your view is what will distinguish your note.
Build a Robust Model
Understanding the past and the present are critical components of your analysis. But this knowledge in isolation has no value to a PM. Every participant in the market has access to the same historical knowledge. What a PM is really interested in is your view of the future.
So many sell side notes focus attention on explaining what just happened: Sales rose by 2%, the company won a new contract, a new CEO was just appointed. This information is necessary to set the context, but it’s far more important to understand how these events impact your view of the future. The tone of your note should always be proactive rather than reactive.
Our clients consistently tell us that an analyst’s forecasts are the most valuable aspect of their work and we encourage all of our analysts to maintain an up-to-date financial model. This model should include the key line items and forecast a minimum of 2-3 years out. All assumptions behind the model should be clearly laid out so that a fund manager could easily adjust the model based on their own assumptions. Rather than being built in isolation, your model should be closely integrated with your research note. The assumptions you make in your model set the context for your investment thesis, and your note should constantly link the two together.
“It’s tough to forecast the future, especially when you know plenty of other experts are going to be listening…but this is what you’re expected to do: make a better prediction of the future than the consensus.” James Valentine, Best Practices for Equity Research Analysts
Tell a Story
In order to have maximum effect, each section needs to be organized as a narrative. You cannot simply dump information on the page with no structure or context.
As explained in section 3, your key drivers form the heart of your research note. With each of these key drivers there will be a narrative to tell – a narrative will typically start with the historical context, goes on to consider the current situation, and then forecast where the company is headed. Along the way you will also want to reference the key characters (management, competitors, shareholders) and key events (macro events, product launches, competitive reactions)
Structuring your note as a narrative in no way implies that you are compromising on objectivity or rigour. And it certainly doesn’t mean you shouldn’t present a balanced view. It simply means explaining your thesis in a context that the PM can intuitively make sense of. Sticking with our hypothetical thesis, a simple narrative might run as follows:
“The past 10 years have been characterized by slow growth as the company has been constrained by the slow-growing nature of the developed markets it traditionally sold into. This changed with the appointment of [new CEO], who charted a course for expansion into the fast growing Chinese market. Now with sales in Asia representing 20%, we expect this region to contribute 3% to the top line over the next 5 years”
“If I had more time, I would have written a shorter letter”
When you’re finished with your note you’ll probably find that you’ve written more than you need to, so read through it a number of times to ensure it’s as concise as it can be. Check that you haven’t repeated yourself – make your point, provide evidence to support that point, and then move on. The whole note should be conclusion-oriented, so remove any text that doesn’t support the overall conclusion.
The use of tables and charts is a powerful way to get a complex point across quickly and reduce the size of your note. But equally you don’t want to overburden the note with irrelevant exhibits. As a rule of thumb your chart or table should be supporting a point you are making in the text in the simplest way possible. If that’s not the case then you should rethink it.
Also look out for areas of the note where you are interspersing text with a large volume of numbers. In these instances it is usually far more effective to introduce a table to illustrate these numbers in a more structured format.
A Final Note
Your skill as an analyst is not linearly correlated with the value you add. You can be a competent analyst, but if you’re telling the PM what they already know then you’re not going to create a lot of value. On the other hand, if you’re an analyst with unique insights that are not well understood by the market, and if you can explain those insights clearly to a PM, then your value increases exponentially. Our aim at StockViews is to identify those analysts who stand out from the crowd and can communicate their research in an effective way. If you count yourself among their number and if you’d like to apply for a position as a StockViews analyst, you can start the application process here.