Equity Research - The Do-It-Yourself guide

Equity research is a discipline of inspecting stocks of a company and forming an opinion about buy, sell, hold or pass backed by data from publicly available sources, and models, propietery and public.

Of late there seems to be a deluge of such offerings at top B-Schools, tech schools and general employment websites. While most of these advertisements tell you what to do- gather information about companies, analyse financial reports, refer to credit ratings, conduct fundamental and technical analysis, analyse the industry and it's peers, and finally prepare database and reports; these thoroughly obscure the fundamental requirement of this- to generate a sound opinion that you want to base your investment decision upon.

And usually it is limited by something called 'the streetlight effect.’ What does this jargon mean? Well it means that most of us pursing such research usually end up looking at places where it's is easy to find the things we hope to find. Usually these are the places where everyone seems to be looking for the same thing. Small wonder the business news channels get such high viewership for their 7:00 AM and 9:00 PM shows!

I personally also feel that as modern jobs are highly mechanized and methods needs to be followed, we inadvertently end up as victims of the street light effect.

Hence we all end up with reports citing data from CRISIL reports, Bloomberg articles and already popular websites that deal in such things, and come up with decisions that are in line with what most of these articles say.

Now here is what is the hardest part in equity research- the decision. To cite this, let me share my personal struggle on such a report about the cement sector and a certain company. I dug up Google like most people, I downloaded tons of reports and tried to process all the information given. Everything seemed to be important! Eventually, when my first draft was conplete it was the sum total of all the reports and their big jargons, as if I was trying to impress myself with my own write up! If you read that report you would have realized that it's was all about how Rosy the industry was, how vibrant the Indian economy was, and how we should all invest in India. Inadvertently, I had just lost track of the objective- buy, sell, hold or pass!

It took long arduous time investment for me to structure the process into something more palpable. It was called risk classification. And that's what has helped me keep my research in line with the objective.

Trust me, it is an easy process and there is absolutely nothing in this world that constant devotion, determination and practice cannot achieve. So burn out those notion of 'averages!'

Start with a macro-economic analysis and answer the simple question- Is India growing at present and can it keep on growing in the upcoming future? If so, at what rate?

Then step into the industry and ask- what is this industry all about? What sells? Where the demand comes from and who are the buyers? Where the supply comes from and who are the sellers? Is the growth in line with the macro-economic growth? It will be prudent to have as much quantitative answers as possible as this helps visualize things better.

Then step into the business and ask- what does this business sell? If it unique or diversified? What is the model of the business that ensures demand capture? Who are it's buyers and sellers? Is it credit laden or in cash? How much of it's clientele are organized players? Remember you need to know three things- is it getting new customers, entering new markets or launching new products. The answer to these three will set you on the path to understand where the growth will come from.

Next, look at the management. This is the most difficult part, and as a beginner just collect the information about the key management personnel from public sources. The objective is to understand what the market feels about them in broad strokes, namely- good, prudent, aggressive, obtuse or cheats.

Finally, take some rest. Let all the qualitative and quantitative data sink into your head. Toy around with the model- the products, the sellers, the buyers, the changing cost of raw materials, the problems of cash flow, etc. Once you have a qualitative judgement about the overall prospects of the company, open the financial statement.

Begin reading the statement by taking a look at the management discussion, followed by auditors report and then the balance sheet, P&L and cash flows. Calculate the ratios that matter- the top line sales, the interest burden, fixed assets, net-worth, working capital cycle, interest coverage and debt service capability, etc. These should paint a picture which should be broadly in line with the analysis you had carried out earlier.

For example, if the industry is highly competitive, you cannot expect the company to have tremendous a level of profit margins. If the ratios do not convey this story, where is reasonable space for doubting the numbers in the public report.

I know all this sounds very tedious and difficult. But that's okay, you do not need to master it in a day, and honestly it ain't possible as well. What you should look for though is finding comfort in your analysis based decision. Irrespective of what professional reports say, if you feel confident about your analysis, you will find confidence for investing. And this confidence will be very different from that you get by hearing other people's opinions and invest according to that!

Just to cover up in conclusion, try reading finance books, the real ones instead of those books that claim to make you rich by just reading them. A very good book to start with is Zvi Bodie's Investments. It is just a great all-round book that has helped me learn a lot. And it is used as a reference at most IIMs.

Happy investing!

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