Best Practices for Equity Research Analysts: Essentials for Buy-Side and Sell-Side Analysts / Edition 1

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A real-world guide to becoming a top-performing equity analyst

Praise for Best Practices for Equity Research Analysts:

"Jim Valentine has taken his decades of experience as a highly successful security analyst and written an effective and comprehensive guide to doing the job right. I

only wish I had this book by my side throughout my career." -- Byron R. Wien, Vice Chairman, Blackstone Advisory Partners LP

"Given the fast pace and high-pressure nature of the markets, analysts don't have the luxury to make mistakes. James J. Valentine's Best Practices for Equity Research

Analysts should be required reading for all new and experienced analysts, particularly those who were not lucky enough to be brought up in the business under a

mentor. Valentine can be that mentor." -- Jami Rubin, Managing Director, Global Investment Research, Goldman Sachs

"Jim's book is an excellent window into the world of securities research. Very few works cover the complete life cycle of an analyst and the necessary balance between

theory and practice. This is one of them." -- Juan-Luis Perez, Global Director of Research, Morgan Stanley

"Valentine's book doesn’t rehash the basics of finance but covers all the nonacademic topics in terms of how the analysts should manage their time, resources,

data, and contacts in order to come up with the best stock picks. This book is required reading for beginning analysts and a must-read for all analysts who want to

develop an edge." -- Carl Schweser, Founder of Schweser’s Study Program for the CFA Exam

"Best Practices for Equity Research Analysts is by far the best written and most comprehensive book that I have read on how to become a top-notch analyst. I shouldn't be surprised; it was written by one of the best analysts that Wall Street has ever seen. Every securities firm should require their analysts to read this book." -- Eli Salzmann, Portfolio Manager

Most equity research analysts learn their trade on the job by apprenticing under a senior analyst. However, equity analysts who work for senior producers often have

little time or incentive to train new hires, and those who do have the time may not have research skills worth emulating.

Now, Best Practices for Equity Research Analysts offers promising equity research analysts a practical curriculum for mastering their profession. James J. Valentine, a former Morgan Stanley analyst, explains everything today's competitive analyst needs to know,

providing practical training materials for buyand sell-side research analysis in the United States and globally.

Conveniently organized for use as a learning tool and everyday reference on the job, Best Practices for Equity Research Analysts covers the five primary areas

of the equity research analyst's role:

  • Identifying and monitoring critical factors
  • Creating and updating financial forecasts
  • Deriving price targets or a range of targets
  • Making stock recommendations
  • Communicating stock ideas

Expanding upon material covered in undergraduate courses but written specifically to help you perform in the real world, this authoritative book gives you access to the wisdom and expertise of leading professionals in the field. You'll learn best practices for setting up an information hub, influencing others, identifying the critical factors and information sources for better forecasting, creating a better set of financial forecast scenarios, improving valuation and stock-picking techniques, communicating your message effectively, making ethical decisions, and more.

Without Best Practices for Equity Research Analysts, you're just treading water in the sink-or-swim world of the equity analyst.

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Product Details

  • ISBN-13: 9780071736381
  • Publisher: McGraw-Hill Professional Publishing
  • Publication date: 12/13/2010
  • Edition number: 1
  • Pages: 402
  • Sales rank: 364,173
  • Product dimensions: 6.30 (w) x 9.00 (h) x 1.50 (d)

Meet the Author

James J. Valentine, CFA, has been an equity research analyst for Morgan Stanley, Salomon Brothers, Smith Barney, and Paine Webber. During his career, he served as Morgan Stanley's associate director of North

American research and its director of global training and development, where he was responsible for implementing new programs for more than 1,000 employees located in financial

centers around the globe. For 10 consecutive years, Institutional Investor ranked him as one of the top three Wall Street analysts within his sector.

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Read an Excerpt


Essentials for Buy-Side and Sell-Side Analysts


Copyright © 2011 James J. Valentine
All right reserved.

ISBN: 978-0-07-173639-8

Chapter One

Do You Have What It Takes to Be a Successful Analyst?

This best practice isn't intended to tell analysts if they are guaranteed to be a success, but rather to make them more aware of their strengths and areas for development. I've recently built an assessment tool for research analysts in conjunction with a consulting firm that specializes in this area. It's still a bit early to draw sweeping conclusions, but my preliminary findings help show how experienced buy-side and sell-side analysts differ from novices and how the degree of experience for sell-side analysts impacts their perspective of the job. Spoiler alert: Don't read this section if you intend to take the online assessment (, as it will undoubtedly bias your responses.

As part of the ongoing assessment development, I survey successful, experienced buy-side and sell-side analysts asking them to respond to questions that ultimately help me understand their perspectives about qualities and skills necessary to be successful as an analyst. As the control group, I'm surveying individuals new to the industry or starting a career in finance. Based on my work to this point, I can draw the following conclusions, ranked in order of greatest statistical significance.

When compared with novices, senior analysts:

• Thoroughly understand inputs to their company's production or creation of their service and the primary markets to which the company sells.

• When recommending a stock, place more focus on the factors where their view is distinctly different than consensus.

• Are more comfortable articulating the strategies of all the companies they follow and how they differ from their competitors.

• When their price target materially differs from the current price, they know where their assumptions differ from the market's.

• Fully understand the peak and trough valuation levels for their companies going back at least 10 years.

• Are more realistic in appreciating that even the best stock pickers don't have 100 percent of the information necessary to make a stock call.

When compared with novices, senior analysts self-assessed themselves to be:

• Less likely to have a calm disposition.

• Less willing to find common ground in times of conflict.

• Not as good at developing and maintaining relationships.

• Less likely to encourage feedback from others.

I've also looked at just the senior analyst population to identify relationships between years of experience and responses to each question. For both buy-side and sell-side analysts, as experience increases, so does agreement with the following statement: "When recommending a stock I like, I focus primarily on the factors where my view is distinctly different than consensus." If you take away only one concept from the book it should be this. Generating alpha is all about determining where consensus is wrong, a concept that often gets overlooked by less experienced analysts.

Among the sell-side analyst population, as their experience increases:

• They gain more job satisfaction from speaking with clients.

• The more they disagree with these statements:

* I build only the bare essential financial model necessary to uncover anomalies and trends.

* I have a generally calm disposition.

* I'm exceptional at finding common ground in times of conflict.

While I continue to learn as more analysts take the assessment, the initial mosaic shows successful, experienced analysts as determined to identify where they differ from consensus, which they do by understanding their companies (and how those companies differ from their competitors) as well as how current valuation differs from the past. When making stock calls, rarely do they have all the information needed. In terms of personality, they tend to be headstrong, independent, and easily roused. This picture is fairly consistent with my observations of successful analysts. I was initially surprised by the solitary qualities that emerged, but upon further consideration, this job isn't a team sport. Although there may be investment committee meetings, most of the work typically conducted by analysts is independent of colleagues (e.g., most firms don't have two telecom analysts), which probably wouldn't set well for someone seeking high interaction with her coworkers. I'm not saying all great analysts are introverted, but rather they need to work and think independently to generate alpha.

While the assessment above helps paint the broad strokes of a typical analyst, interviews with dozens of professionals and a career working with sell-side and buy-side analysts helps to fill in more detail. Here are some attributes of great equity research analysts:

• Intelligent: You don't need to be the smartest person in the room, but given the intense competition, great analysts need to have above-average intelligence. Those analysts who retain what they learn, and can recall it at a later point when needed, are likely to generate more alpha than those who can't.

• Innately inquisitive: As children, their parents may have complained that they were asking too many questions or taking apart things that weren't broken. Friends ask, "Why do you want to know that?" Great analysts are always asking why in an effort to determine where consensus could be wrong. • Self-motivated: There are tens of thousands of other professionals all looking for the same alpha-generating ideas, which means the winners need to be naturally motivated to jump out of bed before 6 a.m., be at their desks by 7:30 in preparation for their morning meetings, and willing to work evenings and weekends to develop an edge.

• Self-directed/resourceful: Akin to reading all of the books in the library, the daily tasks of financial analysis can go into infinitesimal directions, most of which are dead ends. Great analysts don't wait for their managers to tell them the next steps to take or to notify them when they've reached a dead end.

• Focused: There are many distractions in the world of equity research that can consume an entire day but add nothing to the pursuit of alpha. Learning to stay on task and ignore distractions is a big part of the job.

• Risk-taker: All great stock calls require the analyst to be out-of-consensus, essentially telling the rest of the world it's wrong. Waiting for a more comfortable situation, when additional information becomes available, is usually too late because it immediately gets incorporated into the stock price. Great analysts are not uncomfortable when their well-researched thesis is in disagreement with others.

• Influential: We spend a lot of time on spreadsheets but being an equity research analyst isn't just about the numbers. It's also about the people behind the numbers. Much of financial analysis is obtaining good information to make future assumptions, which is facilitated by having an extensive network of contacts. The three areas where it's needed most are (1) getting information from management, (2) getting information from industry sources, and (3) conveying stock ideas to portfolio managers (PMs) (and clients and salespeople for the sell-side). In general, the more influential (charismatic by some definitions) an analyst is, the broader his or her network is, leading to better analysis.

Chapter Two

Take Control to Optimize the Coverage Universe

There are modern-day farmers and ranchers in the western United States who owe some of their success to the luck of their ancestors who took part in land rushes during the 1800s. Similarly, long-term career success and failure for some equity analysts are dictated by the universe of stocks they are initially assigned to cover. Early in their careers, most buy-side and sell-side analysts accept whatever they're given, because they're thrilled to have the responsibility. If you're asked to provide input in defining your stock universe, make sure to seize the opportunity because it's usually short-lived. Be mindful that the managers of research analysts, portfolio managers (PMs) on the buy-side and directors of research on the sell-side, are not in the trenches looking at every stock in a given sector, which means they may not be in a position to provide constructive guidance beyond noticing a broad gap in the organization's coverage that needs to be filled. Having worked in sell-side research management, I had a general idea of what needed to be covered for each sector, but not the expertise to provide a detailed list with justification for every name on it. If possible, try to get ahead of the process and proactively ask your manager for some time to determine the best sectors and companies to cover before being assigned the equivalent of a rocky, barren lot in your land rush.

Here are questions that should be answered in an effort to cover the ideal sectors and stocks:

• Does the analyst have any say in the matter?

• How important are the available sectors and stocks to the firm?

• How many sectors or stocks can be realistically covered and still add value?

* What are the firm's requirements, formal or informal, for covering a sector and individual stocks?

* Will any help be provided by colleagues or outside resources such as off-shore personnel, either now or in the near future?

* How homogeneous and volatile are the potential stocks to be covered?

* Are any sectors complementary or driven by similar factors?

• Where are the analyst's interests?

It's rare for analysts to be given a clean sheet when it comes to selecting a universe of stocks. But that doesn't mean they should just accept what's given. Clearly, they need to work within the confines of their firm or fund (e.g., an S&P 500 fund is limited to those 500 stocks), and avoid picking up anything that's currently covered by a colleague (one of the fastest ways to make enemies is to encroach on another analyst's coverage territory). Beyond that, analysts should assume that their manager doesn't have the assigned coverage fully etched in stone. Taking the bull by the horns and proactively requesting a predefined universe of stocks is somewhat unconventional, and so some or all of this preliminary work may need to be completed during evenings and on weekends to avoid the appearance of wasting time on something that normally occurs on its own. The objective is for an analyst to present a list to a manager that meets the firm's needs while maximizing the analyst's probability of success.

If it appears that the analyst can influence the decision process, the next question should be, "How important are the available sectors and stocks to the firm?" After all, this is the criterion the manager will be using. Some analysts make the mistake of looking only at stocks that interest them; remember that the manager needs to sign off on the list. Buy-side analysts should look to see how often the available stocks and sectors have held an out-sized position in the firm's portfolios. Sell-side analysts should determine how much trading volume and investment banking are done in the available stocks. Although investment banking cannot request that a specific stock be followed by a particular analyst, it can request certain sectors be covered by research.

Now comes the toughest question of all: "How many sectors or stocks can be realistically covered by an analyst and still add value?" Optimally, an analyst wants the largest universe of relevant stocks so as to get noticed without taking on so many stocks that it's difficult to proactively generate alpha (don't forget that each analyst is competing against thousands of others who are all looking for the same alpha). It probably goes without saying that most sell-side analysts cover fewer stocks than most buy-side analysts because sell-side analysts spend a significant portion of their time marketing their ideas and responding to client requests (by some estimates over 50 percent), which takes time away from their research activities.

The question above can't be answered without defining success. What are the firm's requirements, explicit or implicit, for covering a sector and individual stocks? Buy-side analysts are often evaluated only on the alpha generated, while others are expected to provide comprehensive financial forecasts in their firm's system for every company under coverage. This level of requirements needs to be appreciated to determine how much time it will take to properly cover a universe of stocks. Many sell-side analysts are expected to be servicing clients at least 50 percent of their time, while others are allowed to share some of this activity with specialty sales.

Because the role of an equity analyst can be widely varied, for the purposes of this discussion, I'll focus on sell-side and buy-side analysts working for firms with at least five analysts, and who are expected to always have a fair valuation for every stock under coverage. There are plenty of shops with fewer than five analysts, but in these situations the analysts are often expected to cover a third or even half of the S&P 500, which essentially puts them in the category of a portfolio manager. There is a hybrid of these two models: those shops that assign their analysts a large universe but only expect them to focus on a handful of opportunities. Many smaller buy-side shops will ask their analysts to use a funnel approach by starting with a large universe, such as 100 assigned names, and through a screening process, expect that their analysts will self-select a more manageable list, such as 25 names.

Be careful not to cover too many stocks, especially when new to a sector. Based on my experience, the primary reason so many buy-side and sell-side analysts underperform their benchmark is because they're covering too many stocks. I saw this time and time again when I would receive calls from buy-side clients who were asking questions about issues that were no longer truly important to the investment thesis (or never were), illustrating the "day late and a dollar short" adage. This has also been substantiated with academic work (Ramnath, Rock, & Shane, 2008). One study showed that buy-side analysts who covered fewer than 40 stocks, which was the mean for the sample group, did a better job in identifying risks than those covering more than 40 stocks. In a study of sellside analysts, those in the bottom 10 percent for forecasting accuracy covered 21 more firms than analysts in the top 10 percent (Clement, 1999: 300). And more recently, a study found that sell-side analysts' forecasting accuracy improved between 1984 and 2006, due in part to a general trend during that time period of analysts each following fewer stocks and fewer sectors (Myring & Wrege, 2009).

For analysts who just landed the job of a lifetime, it may be tough to tell their boss that they have been assigned too many stocks, but conversely, if they're being asked to research too many, it's a recipe for failure. There are a number of stock- and sector-specific issues that affect the amount of stocks that can effectively be followed (discussed later), but as a general rule, limit it to 35 to 50 closely covered stocks for an individual buy-side analyst and 15 to 20 stocks for a three-person sell-side team. Analysts new to a sector or the investment process altogether should cut these figures in half. There are certainly exceptions to this rule, but based on my experience, the top 10 to 20 percent of buy-side analysts who knew their stocks well enough to be ahead of the crowd and generate alpha were closely covering fewer than 50 stocks. From my perspective as a research manager, the best sell-side analysts were those covering 5 to 7 stocks per team member.


Excerpted from BEST PRACTICES FOR EQUITY RESEARCH ANALYSTS by JAMES J. VALENTINE Copyright © 2011 by James J. Valentine. Excerpted by permission of McGraw-Hill. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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