Before I start off, let me qualify that I have a lot of respect for equity research analysts especially who have substantial experience, competency and professional work ethics. They are far and few between. In addition, I would like to state that I am in no position to criticise or condemn research analysts' reports. Many of the research analysts in our country have strong qualification such as CFA, ACCA, CPA, ACA, CFP and others. All of which also passed the Securities Commission licensing examination specifically on Module 12 & 19. In short, every research reports that were published by licensed institutions are professional opinions permitted by regulators.
Recently due to the wave of downgrades by research analysts covering glove stocks be it in terms of target price or market weightage, it have drawn a lot of "feedback" from the retail investing community. It has come to my understanding that quite a number of retail investors even went as far as to lodge an official complaint to Securities Commission. Market rumour is that Securities Commission also acted on the complaints to commence some level of investigation to ascertain the authenticity and merits of the complaints by retail investors.
The reason I am writing this article today is to merely share my objective viewpoints as a fellow retail investor. Nothing more, nothing less. There is no specific agenda but to somewhat diffuse the negative emotions or sentiment towards research analysts in the current investment climate where retail investors dominate the market participation rate. I think with the large influx of new retail investors in the local stock market since 2020, specifically "Millennial" investors, it is important to have a proper perception and right investment mindset or it may deter or impact future retail investors participation rate. To put it bluntly, if new retail investors feels that the system is rigged and skewed against them in favour of big banks and institutional funds, they would shun the local stock market altogether and that will be bad for the markets. I personally, do not want to see that happening. Thus, it is paramount for us to understand the role, function and structure of research analysts in the full spectrum of the investment banking structure.
To the main focus of the article, are research analysts' reports worth their salt?
In my view, it all comes down to the individual analyst. It is extremely hard to be a research analyst. It is not just about being objective and analysing the companies fundamentals. Textbook theory may be so, but in reality it is far from the truth. This is because no matter what is written, there will be different or opposing view. These are not only views from clients, but also views from management within the organisation outside of the research division whose interest are involved, views of stakeholders, views of regulators, views of retail investors (who may or may not be the client) even views of politicians or government agencies. With many interests at stake, the individual analyst will need to juggle and make all considerations. All is well and good if the organisation has an understanding and respected head of research. What is bad is when the organisation's head of research is a "yes man" or "lalang". To make it simpler for readers to understand the complexity of being a research analysts, I shall segregate the considerations into the following :
1. Competency, Experience & Diligence
In my view, this is the baseline for being a good research analysts whose report is worthy of us relying upon. Most research analysts have qualifications like CFA or accountancy or finance related qualifications on top of their degree. So it goes without saying that analysts are intelligent individuals. Competency is a must in their line of work. Competency involves the ability to derive logical fair value, projecting reasonable future forecast and justifying their forecast with sound rationale. Whether to adopt DCF valuation method, EV/EBITDA or PER multiples with historical and peer comparison, it is the research analysts weapon of choice. The important thing is to make sense. Experience on the other hand have to be acquired. Experience means going through market cycles including bull and bear markets as well as seeing a full cycle of a companies boom and bust. Diligence is the attention to detail, looking at perspective not considered by others and separating wheat from chaff.
2. Integrity or Honesty
This is probably a compulsory qualitative quality that must be a part of a good research analysts. To be honest and objective with their analysis without vested interests or personal agenda such as working with insiders of companies, front running with syndicates or writing reports based on their "key clients" needs, is paramount to being a respected research analysts in the industry. Some analysts who are very intelligent choose to be "intellectually dishonest" by relying on weird or outrageous justification masked in an "eloquent presentation format" to justify their calls be it for the purposes of jacking up the stock price or plunging the stock price. This is in fact the worst thing a research analyst can do as it is unethical and morally wrong to distort truth. To write without fear or favour is hard, but in a way, research analysts are like professional financial journalist who should report the truth based on their analysis of companies without any vested interest.
3. Stakeholder Management
This is one of the more tricky part about being a research analyst. Most people do not know the hardship they face in their line of work. A research report is powerful by nature because it can move the stocks up or down, which means it can increase of decrease the value of companies. Even the most powerful billionaire tycoon are careful when communicating with sell side research analysts. That is why there is a special division called the Investors Relations (IR) within all listed companies. Research analysts when writing reports need to consider the repercussion of their reports. If the companies covered by the research analysts is not happy with the report, they can always block access.
Also, other stakeholders include "key clients". "Key clients" are the one that drives revenue for the organisation. This makes the "key clients" very important. When research analysts reports does not favour the "key clients" position, example : such as a sudden downgrade, it will impact the balance sheet of the "key clients". This is where sometimes, it gets ugly when the sales division interferes with research analysts reports. It is known within the industry that sales always try to please their client and make them happy. So some unethical sales will try to influence research side to tailor made reports to the interests of their key clients. This is where the head of research will need to step in to ensure objectivity.
Lastly, it is internal management stakeholders. Sometimes, the higher ups such as CEO or directors may not be pleased with the research analysts reports which may run afoul of their personal or organisation interest, example : clients they bank or do deals with, imagine the research analyst downgrades or present a less than favourable report of these clients. A research analyst will always be in a difficult position where they have to manage stakeholders while ensuring objective analysis.
4. Economic or Market Environment
Research reports have a pre-determined timeline. Usually it is 12 months. It is not like research analysts can be Warren Buffet and call a hold or buy forever. This means within a tight timeline, research analysts would want to see their stocks perform. This would help them build their reputation, deliver earnings for their "key clients" and draw following from potential new clients. We all know economic or market environment plays an important role. Sentiment especially affects the stock price of a company or particular sector. So with this, what I am trying to get at is that research analysts would likely avoid calling a buy on stocks or sectors which are not the theme of the day. Similarly, if the sector or stock is popular with investors, they would put more focus to it. This is one of the rationale behind how research reports are crafted. It is neither wrong or right, but from a professional capacity, it is what they need to do for the organisation's goals.
Ranking of Analysts
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Food for thought: