Equity research definition
/What is Equity Research?
Equity research is the study of a business and its environment in order to make a buy or sell decision about investing in its shares. This research can also be applied by an acquirer to a prospective acquisition deal, to determine the price at which to bid for the securities of a target company. Equity research can delve into many areas, but tends to concentrate on the topics noted below.
Financial Analysis
The financial analysis portion of equity research focuses on evaluating a company's historical and projected financial performance to determine its intrinsic value and assess its investment potential. This involves a detailed examination of financial statements to understand revenue trends, profitability, and cost management. Analysts use key financial ratios, such as profitability ratios (gross margin, net margin), liquidity ratios (current ratio, quick ratio), and leverage ratios (debt-to-equity), to gauge the company's financial health and efficiency. Historical performance is analyzed to identify patterns or risks, while forecasting involves creating financial models to predict future earnings, cash flows, and potential dividends based on assumptions about market conditions, management strategy, and macroeconomic factors.
In addition to ratio analysis, financial analysis in equity research often includes discounted cash flow (DCF) valuation, comparable company analysis, and precedent transactions analysis to estimate the company's fair value. DCF focuses on estimating the present value of expected future cash flows, while comparable analysis benchmarks the company against similar firms using multiples like price-to-earnings (P/E) and enterprise value-to-EBITDA (EV/EBITDA). Analysts also assess capital structure, cost of capital, and potential risks that might impact financial stability. The goal is to derive a target price for the company’s stock, supporting a buy, sell, or hold recommendation based on whether the stock is undervalued, overvalued, or fairly valued relative to its current market price.
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Disclosures
Examine the disclosures that accompany the financial statements to see if there are any issues that could impact the future value of the company's equity. For example, a firm’s financial statements might disclose that there is a contingent liability that could bankrupt the company if it were to occur.
Industry Analysis
Review the key leading indicators that may predict future conditions within the industry where the target company operates, as well as the impacts of changes in the legal, regulatory, and competitive environment on that industry.
Projections
Combine the information in the company's financial statements with the projections and information gleaned from the industry analysis to arrive at projections for the next few years. This may involve modeling a variety of scenarios to see how they impact the company and the value of its shares.
Risk Management Analysis
All organizations are subject to some degree (and variety) of risk, which you should analyze to see if it has an impact on company valuation. It is essential to consider the impact of lower-probability events on company valuation, such as the impact of a direct hit on company facilities by a tornado, or the expropriation of assets by a foreign government; these factors can have some impact on your analysis of a company’s risk management methods.
Buy Side Equity Research
A person who engages in equity research may work for a buy side investment firm, and apportions his or her time between analysis work, preparing presentations for investment managers, and making the presentations. This job requires considerable financial analysis expertise, spreadsheet modeling skills, judgment regarding whether a possible investment should be recommended, and sufficient presentation skills to make a strong case either in favor of or against an investment.
Sell Side Equity Research
If an equity researcher instead works on the sell side, then the employer is probably an investment bank or research company, and the researcher will be expected to become an expert on an entire industry, within which research is conducted on a number of companies. This information is then packaged for use by the sales force to sell securities to customers. The researcher may make presentations directly to customers, and interact with the investment community in other ways, too. Thus, this tends to be a more visible role than that of the equity researcher whose work remains within a buy side firm.