Vijay Kumar Gaba

Future market price target is usually the least important and most subjective component of an equity research report. The household investors must not act solely based on the “price target” flashed on their TV screens or social media timelines. They must spare sometime to go through the details and get hold of all the strings attached before taking any investing decision.

In a T20 cricket match, a statistical algorithm predicted that chances of Team “A” winning are 79%. The result was flashed on TV screens and a viewer promptly bet a dinner for two on Team “A” victory, with his friend. 

Two overs later, a rookie Team “B” bowler claimed a hat trick and the statistical predictor was now showing chances of Team “B” winning as 83% (from 21% earlier).

The general elections concluded just 3 hours ago. The TV screens were flashing results of exit polls showing Party “A” sweeping the elections with 65% of seats. The ticker on TV however did not show the disclaimer, which said that a 1.2% swing could change the results in favor of Party “B”.

A viewer who had a bet with his wife (a supporter of Party “B”) one year of dishing if the Party “B” wins majority, rued his reliance on TV breaking news for the full one year,

A prominent global brokerage house (XYZ) released a research report for ABC Ltd, giving a 12month price target of Rs400 (against the current market price of Rs210). The TV channels, social media timelines and newspaper headlines flashed “XYZ forecasts 90% gain for ABC Ltd”. Hundreds of investors rushed to buy the stock of ABC Ltd, without caring to read the research report. The report actually built multiple scenarios and highlighted multiple risks. Rs400 target, i2 months hence, was based on a completely blue sky scenario, with no risk playing out. It also assumed that the collective wisdom of market will get influenced by the analyst’s unconventional pricing method for the company.

As it happened – the sky came out to be clouded; some risk factors mentioned in the report also played out and market did not care to agree with the unconventional pricing method of the analyst. The stock price plunged to Rs75 a year later. Most investors booked losses; cursed the analyst and alleged him to be in cahoots with the unscrupulous market operators and corrupt company management.

Indifference to details may be one of the most unfortunate parts of the entire investment process of household investors (commonly referred to as the retail investors). In their eagerness and greed to make money faster than others, these investors usually act on headlines without actually caring to go into the details. It is also seen that the reliance on “Research Reports” by the household investors is mostly misplaced. Most of them only care to read the “price target”, without going into the analysts’ rationale for such target; or caring about detailed analysis of the business of the company. For household investors, it is critical to understand the types of equity research reports and their components.

Types of equity research reports

Equity research reports are prepared for a variety of purpose. The constitution of the report usually differs according to its purpose. For example -

The most common equity research reports are the Sell Side Initiation and Maintenance reports. These are reports prepared by research analysts employed by various brokerages for the purposes of marketing their investment ideas to the clients. The initiation report is the first report on a company by a particular analyst. This report usually contains a detailed quantitative and qualitative analysis of the company. After the initiation report is released, the analyst then releases periodic maintenance reports to update the original data for the new developments like quarterly results; corporate actions, and policy changes etc.

Second popular types of reports are “deal reports”. These reports are prepared by the investment banking research analysts to market the proposed equity issue of the underlying company to the institutional investors. These reports usually have an inherent bias in favor of the underlying company.

Third type of popular reports is “buy side equity research” reports. These reports are usually prepared by the research analysts of the investing entities (e.g., mutual funds, private equity funds etc.) for their internal use purposes. These reports usually are influenced by the guiding principles and investment strategy of the investing entity; and hence may not be relevant to all classes of investors.

The focus, content and emphasis of various types of reports are different based on their objective. Household investors cannot exclusively rely on these reports, made available to them on social media, blogs or friends in right places, for their investment decisions.

Components of a Research Report

The components of an equity research report would depend on its objective and target audience. The basic components of the most popular a “Sell Side Equity Initiation Research Report” would usually consist of following-

·         Description of the Company – Historical background, business, facilities, capacities, promoters, key management, etc.

·         Analysis of the business – Products, applications of products, competitive landscape, demand-supply dynamics, emerging trends, technological advantages, etc.

·         Analysis of finances – Historical trends in capital structure, cost of capital, capital allocation efficiency, leverage sustainability, solvency, advantages (or otherwise) relative to competition etc.

·         Analysis of profitability – Historical trends in margins, growth, return on equity, sustainability of margins etc.

·         Future Projections – Profitability, Growth, Solvency, Sustainability Competition etc. over next 2-4years.

·         Risk factors – Risks to the business, finances, profitability and forecasts

·         Actionable – Buy, Sell, Hold, Accumulate, Reduce etc.

·         Price target – Expected market price of the stock on a given future date.

There are many sources for the details provided in the research reports, e.g., – (i) Factual data available from historical records; (ii) Published research by professional research organizations and Institutions like CRISIL, CMIE, NSSO, RBI, IMF, etc.; (iii) Management presentations and company reports; (iv) Market research by the analyst himself; and ((iv) Analysts’ estimates., etc.

The suggested action (buy, sell etc.) is based on the estimated relative performance; implying that the stock of that particular company is likely to do better (or worse or in line) than competition and/or benchmark indices. In many cases, the actionable is actually not based on the estimated absolute performance of the stock price.

Future market price target is usually the least important and most subjective component of an equity research report. This piece of data in a report is heavily influenced by the analysts’ subjective perception of the business, growth, profitability, and the method of valuation used to derive such target. It is therefore common to have vastly different price targets given by different analysts at the same time, for the same stock

It is akin to a TV commentator forecasting a team’s score in a 50 over match at the beginning of the inning based on the weather conditions, grass on the pitch, and performance of key batsmen & bowlers in previous five innings, etc. Even though their analysis and forecast are based on their experience and available information, their forecasts about the total score seldom come true.

The household investors therefore must not act solely based on the “price target” flashed on their TV screens or social media timelines. They must spare sometime to go through the details and get hold of all the strings attached before taking any investing decision.