Title: Best Practices for Equity Research Analyst
Author: James J. Valentine, CFA
Publisher: McGraw Hill (December 2010)
ISBN – 10: 1-25-900395-7
ISBN – 13: 978-1-25-900395-0
Reviewer: Namrata Shah
Best Practices for Equity Research Analyst acts as a handbook for an analyst. The book highlights day-to-day life of both buy-side and sell-side analyst. The author repeatedly emphasis the importance of generating alpha and provides road map for analyst to achieve it.
The book is divided into 6 parts. A brief description for each part is given below:
Part 1: Mastering organization and Interpersonal skills
This section focuses on non-technical areas as selecting optimal universe of stock (important to generate alpha. However, stock universe can be increased, if the stock is homogenous or in same food chain), time management (James shares effective time management tips and application of ‘delegate, automate or outsource’ theory. Other areas of focus are influencing skills, managing information flow and maximizing sell-side benefit
Part 2: Generating Qualitative Insights
This section focuses on elements to identify sector’s performance and critical factors affecting stock. James emphasis that best analyst must focus much of their time in identifying, tracking and monitoring stock’s critical factors. To identify stock critical factors, the timing of associated catalyst (material changes in earnings, cash flow, senior management or likelihood of an acquisition) must be monitored. Further the impact of catalyst on investor’s confidence and implied control premium must be considered.
To excel, he suggest that a short-list of critical factors be kept handy and analyst be active to lookout for new critical factors that impact the companies covered. Later part of section explores ways to get most benefits from interviewing company’s management and other industry leaders. James highlights the role of body language and application of mosaic theory.
Part 3: Generating Quantitative insights
This section focuses on quantitative tool for statistical analysis and use of Microsoft excel. James emphasis that data to be used for analysis, making charts and finding ratios must be thoroughly reviewed to identify deception if any presented in data and adjusted for seasonality, inflation factors.
James emphasis the importance of detecting early warning signs (referred as yellow flags). This is supported by must “look in” factors while reviewing balance sheet, income statement or cash flow statement. In addition to this, analyst must also consider business and regulatory issues faced by the company.
The required knowledge of Microsoft Excel for analyst is divided into three sections:
- Excel features – excel’s 43 most applicable features for research
- Creating spreadsheet architecture – creating spreadsheet that are easy to use and enables easy generation of business insights.
- Developing company’s financial model – information about elements required for setting up and building company’s financial model.
Part 4: Mastering Practical Valuation and Stock Picking Skills
This section focuses on valuation methods. The author prefers use of multi period cash flow (DCF) over single period multiples (using forecast metrics – earnings, cashflow or book value) to justify stock value.
Further, to generate alpha return on stock, the analyst must focus on three aspects – forecast, valuation and sentiments. To highlight these three aspects, author has coined term ‘FaVeS’TM. The analyst must evaluate whether the estimates given by him are in accordance with the consensus, if not, then James advocates that analyst must ensure the component of research undertaken by others and factors that leads to major difference in the stock estimates.
The author discusses about the questions that analyst needs to answer before making a stock call and considerations for price targets. James gives a good insight on parameter that should be taken while setting exit threshold for the stock. Use of technical analysis as a tool to support fundamental stock value is also recommended.
Part 5: Communicating Stock ideas so others can take action
To facilitate effective communication by analyst, regardless of means of communication, the author emphasis five element framework – ‘ENTERTM’ (Exceptional, Novel, Thorough, Examinable, Revealing). However, its important the analyst focus on optimal communication channel. Further, to ensure that message has value and is clear, author has designed proprietary framework – ‘CASCADE’ (Conclusion – oriented, Appealing, Stock-oriented, Concise, Aware, Data-driven, Easy-to-understand).
Part 6: Making Ethical Decision
James list down potential ethical dilemma that analyst may encounter during their professional journey and provides list of criteria that analyst should consider while taking proper course of action.
To facilitate quick read, chapter summary is provided at end of each chapter. Further, the book is full of best practices points (which act as checklist), flowchart (providing a direction to analyst thoughts) and examples. All of which are thoroughly detailed. The book acts as a comprehensive guide tool for analyst, aspiring analyst and portfolio managers.
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