What is an Equity Research Report?
An equity research report may focus on a specific stock or industry sector, currency, commodity, or fixed-income instrument, or even on a geographic region or country, and generally make buy or sell recommendations. These reports are produced by a variety of sources, ranging from market research firms to in-house research departments at large financial institutions or boutique investment banks.
Key Learning Points
- An equity research report is a document prepared by an analyst that provides a recommendation to buy, hold, or sell shares of a public company.
- An equity research report is a document prepared by an analyst who is part of an investment research team in a brokerage firm or investment bank
- It provides an overview of the business, the industry it operates in, the management team, the company’s financial performance, and risks, and includes a target price and investment recommendation.
- It is intended to help an investor decide whether to invest in a stock.
Equity Research Report Structure
An equity research report can include varying levels of detail, and although there is no industry standard when it comes to formatting, there are common elements to all equity research reports. This guide includes some fundamental features and information that should be considered essential to any research report, as well as some tips for making your analysis and report as effective as possible.
Access the download to see a real-world example of an Equity Research Report, annotated to show each element discussed below.
The research report should begin with basic information about the firm, including the company’s ticker symbol, the primary exchange where its shares are traded, the primary sector and industry in which it operates, the current stock price and market capitalization, the target stock price, and the investment recommendation.
In addition, a security’s liquidity and float are important considerations for the equity analyst. The liquidity of a stock refers to the degree to which it can be purchased and sold without affecting the price. The analyst should understand that periods of financial stress can affect liquidity. A stock’s float refers to the number of shares that are publicly owned and available for trading and generally excludes restricted shares and insider holdings. The float of a stock can be significantly smaller than its market capitalization and thus is an important consideration for large institutional investors, especially when it comes to investing in companies with smaller market capitalizations. Consequently, a relatively small float deserves mention. Finally, it is good practice to identify the major shareholders of a firm.
This section should include a detailed description of the company and its products and services. It should convey a clear understanding of the company’s economics, including a discussion of the key drivers of revenues and expenses. Much of this information can be sourced from the company itself and from its regulatory filings as well as from industry publications.
Industry Overview and Competitive Positioning
This section should include an overview of the industry dynamics, including a competitive analysis of the industry. Most firms’ annual reports include some discussion of the competitive environment. A group of peer companies should be developed for competitive analysis. The “Porter’s Five Forces” framework for industry analysis is an effective tool for examining the health and competitive intensity of an industry. Production capacity levels, pricing, distribution, and stability of market share are also important considerations.
It is important to note that there are different paths to success. Strength of brand, cost leadership, and access to protected technology or resources are just some of the ways in which companies set themselves apart from the competition. Famed investor Warren Buffett describes a firm’s competitive advantage as an economic “moat.” He says, “In business, I look for economic castles protected by unbreachable moats.”
This section should include a brief description of the company, significant recent developments, an earnings forecast, a valuation summary, and the recommended investment action. If the purchase or sale of a security is being advised, there should be a clear and concise explanation as to why the security is deemed to be mispriced. That is, what is the market currently not properly discounting in the stock’s price, and what will prompt the market to re-price the security?
This section should include a thorough valuation of the company using conventional valuation metrics and formulas. Equity valuation models can derive either absolute or relative values. Absolute valuation models derive an asset’s intrinsic value and generally take the form of discounted cash flow models. Relative equity valuation models estimate a stock’s value relative to another stock and can be based on a number of different metrics, including price/sales, price/earnings, price/cash flow, and price/book value. Because model outputs can vary, more than one valuation model should be used.
This section should include a detailed analysis of the company’s historical financial performance and a forecast of future performance. Financial results are commonly manipulated to portray firms in the most favorable light. It is the responsibility of the analyst to understand the underlying financial reality. Accordingly, a careful reading of the footnotes of a company’s financial disclosures is an essential part of any examination of earnings quality. Non-recurring events, the use of off-balance-sheet financing, income and reserve recognition, and depreciation policies are all examples of items that can distort a firm’s financial results.
Financial modeling of future results helps to measure the effects of changes in certain inputs on the various financial statements. Analysts should be especially careful, however, about extrapolating past trends into the future. This is especially important in the case of cyclical firms. Projecting forward from the top or bottom of a business cycle is a common mistake.
Finally, it can be informative to use industry-specific financial ratios as part of the financial analysis. Examples include proven reserves/shares for oil companies, revenue/subscribers for cable or wireless companies, and revenue/available rooms for the hotel industry.
This section should address potential negative industry and company developments that could pose a risk to the investment thesis. Risks can be operational or financial or related to regulatory issues or legal proceedings.
Although companies are generally obligated to discuss risks in their regulatory disclosures, risks are often subjective and hard to quantify (e.g., the threat of a competing technology). It is the job of the analyst to make these determinations. Of course, disclosures of “qualified opinions” from auditors and “material weakness in internal control over financial reporting” should be automatic red flags for analysts.
Environmental, Social & Governance (ESG)
This section should include information on how the company manages the relationships related to Environmental, Social, and Governance. Below are some examples within these three areas that can have a lasting impact on the company’s short- and long-term prospects:
- Environmental – how is the company working towards the conservation of the natural world? This can include climate change and carbon emissions, air and water pollution, energy efficiency, waste management, and more.
- Social – how does the company consider people and relationships? This can include community relations, human rights, gender and diversity, labor standards, customer satisfaction, and employee engagement.
- Governance – what are the standards for running the company? This can include board composition, audit committee structure, executive compensation, succession planning, leadership experience, and bribery and corruption policies.
Enroll in our online ESG course and learn to identify the principles of ESG and how they are applied to investment strategies.
If you are interested in a career as an equity research analysts or in fixed income research, our online course covers all the key skills needed as either a sell side analyst in an investment bank or a buy side analyst working in an investment management firm.