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Equity Research, Brief process guide

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Equity research is a part of investment banking sector in nature. It’s a part of intellectual and quantitative calculations and analysis.
Equity research primarily means analyzing company’s financials, perform ratio analysis, forecast the financials (financial modeling) and explore scenarios with an objective of making BUY/SELL stock investment recommendation. Equity research analyst discuss their research and analysis in their equity research reports (ER Reports).

Looking into the table, it is clear that ER is all about making valuation of listed companies (i.e whose shares are listed/traded in stock exchanges).

First thing to consider is, which company’s stock we are looking to BUY or SELL?
Once  we are done with the selection of company under consideration, we should consider the macro-economic aspects like Economic growth rates, GDP, market size and effect of inflations/interest rates over there.

With the economic factors and aspects behind the business in which the company is operating, it should move forward for the analysis of financial statements. To start with, we have to analyze the historical financial statements including significant disclosures and contingent aspects, which will help us to build up a opinion regarding past performances, financial positions and cash flow operating cycle. during fundamental analysis, we should include precise and relevant information, reason is that a slight change in numerator or denominator may impact a huge change in historical financial ratios. For example, we should investigate the terms like shareholders fund, restricted funds, regulatory funds/liability, funds collected and fund used, non-cash items, tax expenses etc.

Now, based on management’s expectations, visions & missions, new expansions under consideration, market reactions, historical records and trends, industry competition, correlation with the industry movement, regression analysis, we need to prepare a projected financial statements/informations like Balance sheet, Income statement, cash flows, funds flows, of the company. And is called by “financial modeling” under ER.

Don’t be so confused with financial engineering and financial modeling at this step, because both of the intelligence has different scopes, objectives, methods and users. financial modeling is the core process of ER, result of which determine most of the investment decisions. Now, while using it, there are different valuation approaches and models with few limitation and strengths. But the thing we have to consider is the relevancy and reliability of inputs and assumptions used for the inputs.
For example, when we are using discounted cash flow model, the major thing we have look carefully is, calculation of discount rates and estimation of cash flows over the period under consideration and risk factors. after all, the reliability of output will depend on the source and methods used to calculate the inputs.

At last but not the least, it’s up to the researcher for comparison of fair value data result of financial modeling with market data and to make a decision on BUY, HOLD or SELL.

-Rohit Dhital,
Chartered Accountant
rohit.dhital@gmail.com

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