How do all those guys on CNBC give your recommendations on stocks? How do Mutual Funds or Wealth management companies decide which stocks to invest in? The answer lies in the extremely interesting field of Equity Research.
Broadly, there are two methods of analyzing a stock – one, called the ‘Fundamental’ approach, looks at the economy, industry and the company’s financials, and then arrives at a value. The basic idea here is, the price of a stock should, finally, reflect its actual value.
It often doesn’t. Prices are also driven by herd mentality, fear, greed and demand-supply mismatches. Technical Analysis, the other form of analysis, is based on the principle that past investor behaviour will repeat in the future. It involves pure analysis of the past patterns of stock price movements.
The fundamental approach, is what is referred to as ‘Equity Research’.
The research starts off by looking at the economy – country – the company is in. So, where is India headed? Is the country’s economy growing? If, for example, we’re evaluating an automobile company such as Tata Motors, how is consumer purchasing power?
We’d then move on to the specific Industry. For the auto industry, we’d look at the current and near future interest rate movements, as well as prices of petrol and input costs like steel prices. Why interest rate movements? The automotive sector is what is called ‘Interest rate sensitive’. Higher interest rates means higher cost of loans, and lower consumer demand. Petrol prices also affect consumer demand, and input costs can affect profit margins, if prices aren’t increased. Price increases can again affect consumer demand. Any Government regulations affecting the sector should also be factored in.
An understanding of the main market players, typical profit margins and industry growth rates is necessary, so you can benchmark this company against its peers.
An Analyst starts off by doing some basic analysis such as calculating ratios using standard templates built in-house, but soon starts specializing in a particular sector such as IT, Healthcare, Auto, etc. We see above that she needs to acquire in-depth knowledge of a particular sector, in order to grow as an Analyst.
It’s a fairly flat structure. You’ll grow quickly to doing the complete analysis of a company, though the final report and recommendation (Buy?/Hold?/Sell?) is done by the head of Analysis for that sector.
Which companies do I join?
Research Analysts can join brokerages, such as India Infoline Ltd (IIFL), Motilal Oswal, Angel Broking, etc. These brokerages have intensive research divisions, so that they can advise their clients.
Global investment houses such as Goldman Sachs, Nomura have their captive research units (KPOs) in India, where Analysts will research not just Indian stocks, but stocks in other markets too. Traders will make decisions, or recommend investments to clients, basis this analysis.
Mutual Funds may have an in-house research division. Large players like HDFC Mutual Fund, Reliance Mutual Fund etc are some names.
Chartered Accountants, with their strong analytical skills plus familiarity with financial statements, are a great fit with this role. It’s also interesting, as you’re constantly learning – and over a period of time, will acquire deep expertise about an entire industry. It’ll help your personal investments, too.
A professional degree like an MBA or CA, is good to have, especially for the higher end KPOs. It is a good idea to enhance your CV with the necessary training and an industry recognised certification. An extremely relevant one is the FLIP-NSE (National Stock Exchange) certification on Equity Research. (http://www.nseindia.com/content/ncfm/ncfm_eq_research.htm)
As always, I hope you found this useful – keep your comments coming in!