How can I produce a great equity research report?

It’s clearly a question lots of people want to answer.  It's the question most often asked on the training programmes I run.  (You can find a typical outline here: Download Kairos_EquityReportWriting_proposal).  My Slideshare presentation, How to Write an Equity Research Report, has enjoyed 33,000 hits since I uploaded it in 2009.  (Take a look.  Click on the image.)

 

 

 

 

 

Large investment brokers print maybe 1,000 pages of research each week.  And a further 1,000 electronic pages.  A large fund management house receives maybe 7,000 envelopes of research in the post every Monday morning.  Maybe your report is in there somewhere, competing with 500 other researchers for your reader’s attention.

How will you make your report stand out from all the rest?  After all, you all have access to the same information (presumably). 

It’s not about the information.  It’s about the idea.

Why is your reader reading it?  Not to understand how you did the research.  Not to explore the finer points of a company’s profit margins or acquisitions policy. 

Your reader wants to know how to deal.

And only you can tell them.  No amount of information will do that job.  No algorithm, no software, however fancy, can give them that answer.  Only you, with your uniquely powerful human mind, can persuade them to deal.

So: the one thing you need to do to produce a great research report is take a position.

Don’t do what everyone else is doing.  Anyone can comment on the trends in financial statements, or compare a company’s valuation metrics with those of its peers.  And they do. 

Be different.  Find something interesting to say. 

Ok, that’s not easy.  It’s hard: most of the interesting things have been said. But having something to say is your job.  It’s what you’re paid for.  It's what puts us ahead of the computer.

If you really want to get ahead, study the craft of persuasion.

Here are three signposts to head you in the right direction.

• Find the story,
• Construct an argument.
• Bring it alive.

 

Find the story.  Use this simple narrative structure to help you. 

Situation: What are the market’s assumptions about this stock?

Problem: Why are the market’s assumptions wrong?

Question: What’s the key question arising from my insight?

Response: What’s my position?

SPQR:  you might recognise it as the motto of the Roman Republic.  That might help you remember it. (There's more about this structure here.)

How do you find the Problem in this sequence?  Daniel Martins, in a recent post on Linked In, suggests that every good stock call meets at least one of two key criteria: results and valuation.  He gives the example of a ‘buy’ call:

“1.Better-than-expected results. The analysis must show evidence that the company whose stock is under analysis will perform better than consensus seems to expect, in the case of a "buy" call. Little does it matter if I believe Facebook will double its earnings by 2018. The real question is: does the market ... believe that the company will grow earnings at a faster or slower pace than what I expect? If the latter, then maybe I have a "buy" recommendation in the works.

2.Higher valuation. For a "buy" call, the analysis must support that "the market" should and will value the company's stock at higher multiples (or the present value of the company's future cash flows at a lower discount rate). For example, is it fair that Apple’s stock be valued at 12 times the company's 2016 EPS consensus estimate?”

A 'sell' call would go the opposite way: you predict worse results and a lower valuation than consensus.  The trick is to put your position in context. 

Ok.  So you have your position.  Now you need to:

 

Construct your argument.  What makes an argument convincing?  Two things: logic and imagination.

Logic first.  The basic form of an argument is simple: [A] because [B].  Martins offers this hypothetical argument:

"Stock XYZ is a 'buy' because the company's flagship product will continue to be in high demand, as the Internet of Things continues to grow at a fast pace in the next 5 to 10 years".

The logic just isn’t there.  The word 'because' is doing no work.  As Martins says:

“While the statement may suggest that Company XYZ is in a high-growth industry, it tells me nothing about whether I expect (1) the company's future results to beat expectations and/or (2) the stock to be valued at higher multiples than it is now.

“In other words, it tells me nothing about whether the stock is a good buy.”

He suggests that the logic is stronger in this argument:

"Stock XYZ is a 'buy' as I expect EPS to grow 20% faster than the market projects in the next five years, and because the probable deleveraging of the company's balance sheet should lead to lower perceived risk and P/E expansion to 15 times."  

And hey!  You can impress us with your analytical skills.  But do so, please, in support of a robust argument.

 

Bring it alive.  Now, imagination.  Every argument in the real world depends on an appeal to more than logic.  We all know that smoking is bad for our health, but no amount of statistics can compare in impact with the picture of a lung ravaged by cancer – or, alternatively, the story of Uncle Basil who smoked 50 a day and lived into his nineties. 

Bolster your argument with material that stimulates your reader’s imagination.  Give your reader images, concrete examples, stories.  Use rhetorical devices. (Tricolons; antithesis; erotema. Look 'em up.  Learn, my friend, learn the craft.)

Make the argument human.  Jon Cooper, in a great posting on Quora, has this useful checklist (thanks, Jon):

Who are the players in this industry? What personalities are involved, either as corporate entities, or the specific people involved?

What are their inputs and outputs? What’s going on in those markets? Is the secular trend in market participants growing or shrinking? How about market size? How about supply constraints?

When are they chronologically weak or strong? Are there cross-industry dynamics in time that matter? How about intra-industry? Any regulatory changes on the horizon?

Where do these players operate? What’s going on in those localities?

Why have these players chosen the courses of action that they did? Is there evidence that the criteria they chose to set their direction are the right ones? Do you agree with their professed rationales?

How do these players view themselves and their peers? How are they viewed by other powerful actors that matter?

Check out, also, this blog post.  You’ll find plenty to inspire you there.

So: why do so few analysts dare to take a position?

Simple.  They don’t want to be wrong. 

And, many times, you will get it wrong.  But, you know: that’s not the point.  As Cooper says: “Whether you are right or wrong matters less than that you express a point of view that engenders a thoughtful conversation with the folks who will commit risk dollars.”

We're not academics.  We're in business.  The point is not how accurate your predictions are, but whether you provoke people to deal.

A reminder: I run training and coaching programmes for research analysts.  You can find a typical outline here:

Download Kairos_EquityReportWriting_proposal