How to Write an Equity Research Report PURPOSE

How to Write an Equity Research Report

PURPOSE OF A RESEARCH REPORT • What is the purpose of a research report? - Provide. . . - Relevant content - Unique insight and perspective . . . that will enable the reader to make an improved decision • What is it not? - Data dump - Value the reader’s time; use your space thoughtfully - More is not better. . . better is better. Data should be useful and easy to read - Inaccurate - You want conviction. . . but where possible let facts do the heavy lifting. - Don’t publish misleading information; seek economic truth! 2

KEY ELEMENTS OF A REPORT • Investment Summary • Business Description • Industry Overview • Competitive Positioning • Financial Analysis & Trends • Valuation - Methods and Model Assumptions • Investment Merits and Risks • Other Relevant Topics 3

INVESTMENT SUMMARY • In a handful of bullets, describe: - the company’s business model; - the key tenets of the investment thesis; - the key risks to shareholders; - its fair value; - and the expected return for buyers at the current market price 4

BUSINESS DESCRIPTION • Reader should get a brief intro - What do they do? - How do they make money (manufacturer, brand franchise, professional service, distributor, risk transfer, innovation, etc. ) - Changes in business mix/profile? - Who are their customers? - Business, consumer, government, etc. - How do they reach their customers? - Brick and mortar, direct sales, internet, catalog, etc. - Where do they operate? - Domestic, international (developed countries, emerging markets), etc. • Other - Major segments - Financial profile (growth rates, margins, leverage, cash flow) - Major recent developments worth mentioning 5

INDUSTRY OVERVIEW • Target addressable market(s) - Current and future growth rates - Industry life cycle • Market characteristics - Monopoly, Duopoly, Oligopoly - Global, regional, or local marketplace • Key industry demand drivers - End markets - Secular vs. cyclical trends • Industry trends - Globalization - Consolidation - Regulatory oversight 6

COMPETITIVE POSITIONING • What differentiates competitors? - Cost structure, scale, product/service quality, technology, intellectual capital (human, patents), customer relationship, geography, etc. • Porter’s Five Forces. . . he was onto something! - Rivalry – industry structure, S/D dynamics, fixed vs variable costs, exit barriers New entrants – barriers to entry (scale, capex, patents, product differentiation, etc) Substitutes – switching cost, relative price and quality Buyer power – concentration, product differentiation, integration threat, switching cost, co-dependence - Supplier power – similar to buyer power. . . • Market share - Market participants’ market share - Historical and projected gains/losses 7

FINANCIAL ANALYSIS & TRENDS • Historical and Projected IS / BS / CFS - Margins (gross, EBITDA, EBIT, net, etc. ) and growth rates - ROA / ROE / ROIC - Cash flow (OCF, FCF; per share and margin) - Sources (OCF, divestitures, share/debt issuance, etc) and Uses (Divvy, share/debt repo, acquisitions, capex) of cash - Working Capital (cash conversion cycle; % of sales) - Leverage (D/EBITDA, DTC, etc. ) - Capital requirements & Liquidity - Current/quick/cash ratio; covenants and debt maturity schedule - Appreciate the difference between liquidity and leverage! - Other industry specific metrics • Compare relevant metrics to competitors 8

FINANCIAL ANALYSIS & TRENDS - TIPS • Projected IS / BS / CFS should tie together • Make sure you don’t have runaway metrics - Projections should make economic sense • Don’t be mechanical; customize your analysis to the specific company and industry • Don’t take this section lightly! - Easy to mess up - Should be consistent with your qualitative assessment - Ultimately drives your valuation and recommendation 9

VALUATION • Valuation is an art, not a science. . . • Discounted cash flow - Growth and margin assumptions - Terminal value and discount rate • Multiples (P/E, P/FCFE, EV/FCFF, EV/EBITDA, EV/EBIT, EV/S) - User beware - When using multiples you implicitly accept historical multiples as an accurate assessment of value - Underlying a multiple is math. . . make sure it works and understand the logic - Peers (make sure similar attributes) Transactions (make sure similar attributes) Historical (make sure the company hasn’t changed) Market 10

MODEL ASSUMPTIONS & RISKS • Garbage-in, garbage-out • DCF model assumptions - Margin assumptions - Revenue drivers, bottom-up where possible - Cost drivers, bottom-up where possible - Discount rate - Long-term growth rate; forever is a long time. . . be conservative - WACC/FCFF or Ke/FCFE - Terminal value - Be careful - “Similar to the Hubble telescope. . . move an inch and you’re in a new galaxy” • Risks to estimates - Micro misses – fundamental economics of business change, industry landscape - changes, balance sheet impairs equity owners Macro misses – recession, interest rates, inflation, etc. 11

INVESTMENT MERITS • What attributes make this a good investment? * - Favorable fundamental attributes - Strong market position, pricing power, strong brand, favorable outlook - Attractive industry landscape - Barriers to entry, rational competitors, secular tailwinds - Balance sheet flexibility - Attractive valuation - Good capital allocators - Favorable ST/LT outlook * Assumes a buy recommendation 12

INVESTMENT CONCERNS • There are literally pages of risks listed in the 10 -k • Ask yourself. . . what could go wrong? - Company specific - Customer/supplier concentration, cost inflation, loss of key product, substitution, balance sheet deterioration, headline risks - Industry specific - Increasing competitive landscape, unfavorable regulatory changes - Macro environment - Recession, interest rates, inflation, currency 13

OTHER RELEVANT POTENTIAL HEADINGS • Management summary - Executive profiles, recent changes, proxy statement • Ownership summary - Top shareholders, institutional ownership, insider ownership • Recent business initiatives / developments - New business segment, marketing and/or product strategy - Acquisitions or divestitures - Not always good. . . headline risk, manufacturing problems, regulatory changes, etc. • Recent balance sheet changes - Changes in capital structure, changes in debt or equity 14