June 20, 2021

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Are Research Analysts’ Reports Worth Their Salt?

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 criticize 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.  

Research division as a standalone cannot make money. However, with their research reports, they generate trade ideas for their clients which in turns bring in revenue for their organisation via the brokerage firm or bank. So who are the clients in which they serve? Traditionally, it have always been the large institutional funds such as asset management companies, hedge fund, pension fund, mutual fund, insurance funds etc. Retail investors play a very insignificant role as the market participation is largely skewed towards institutional clients. Of course, this have changed significantly over the course of the past 2 years in part due to the rise in lower cost of participation for retail investors and also low interest rate environment. Locally, we can see some brokerage firms or banks do particularly well as their focus is towards retail investors. Immediately that comes to mind is Kenanga / Rakuten, CGS-CIMB amongsts others. It is important to know this to understand the role of research analysts and who are their "main clients". Their "main clients" were never retail investors but big institutional funds. 

After understanding their role and their clients, it is important to understand the organisation chart with the research division. The most senior person would be the head of research. He is the captain and final approval level before the research reports goes out to public. Then it would be the senior analysts who are usually seasoned and experience analysts who may even be known as "sector specialist". Example : a senior analysts covering banking stocks may be even more experienced than the head of research as a sector specialist probably due to the years of experience covering the sector. This sector specialist research analysts also have good network with the companies in the sector they are covering.


Then the lower levels would be associates and junior analysts who are mostly "generalist" where they cover whichever sector or companies allocated to them by the head of research. As a junior in the organisation, they would have to do most of the grunt work and across sectors subject also to availability. Sometimes, fortunate "junior analysts or associates" is given the chance to be "sector specialist" if they show a knack or potential for their particular role. The interesting thing about the research division is that mostly anyone who is qualified, licensed by Securities Commission and approved by the head of research can issue 14a research report with their name on it. Most research analysts take pride in their name being printed. Just like an author of a book.

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

Unknown to many, analysts are ranked annually by their clients. It is important to them especially if they ranked higher. It justifies promotion and increment for them. For clients to rank them higher, the most important criteria is getting their calls right and service level. In fact, for years now, The Edge also gives out best call awards to analysts to recognise their efforts. You can see the awards in 2020 and 2019. The awards are not all encompassing but it shows some of the analysts who did very well for the year. Of course, one or two good calls doesn't mean anything. Many good analysts actually fly under the radar and consistently churn out high quality reports. Even if the stocks don't perform, a hold or a downgrade call is equally important. What matters most is about giving an informed judgment which is reasonable, the outcome is not within anyone's control especially when the timeframe is merely 12 months.

Conclusion

The industry is very small, some even call it a "musical chair" industry. This means that because there is limited positions in this sector, many research analysts move around from organisation to organisation. As it is small, it is hard to get in. Newcomers have the opportunity only when the old timers leave. I believe there are many good research analysts in the stock market. As investors or readers, we should be discerning of the reports and seek out the good ones to follow closely. Many like to follow stock market "Gurus", of which plenty are charlatans and fraudsters. Those you see on advertisements or sponsored videos, majority are fake. Following good research analysts reports is much better than "fake Gurus". At the very least, they are regulated and they have a professional risk of losing their license if they violate regulations.

I hope retail investors especially new ones do not disregards research analysts over the gloves downgrades because sometimes, it is at no fault of theirs. As long as you filter out the good ones from the "intellectually dishonest" ones, I believe research analysts' reports have great value especially their access to management and deeper insights which normal retail investors wouldn't have. In addition, for research analysts who are "sector specialist", they have very sharp observations that we retail investors would otherwise miss due to our more generalist approach in investing across sectors.


Food for thought: 

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This  information should not and cannot be construed as or relied on and (for  all intents and purposes) does not constitute financial, investment or  any other form of advice. Any investment involves the taking of  substantial risks, including (but not limited to) complete loss of  capital. Every investor has different strategies, risk tolerances and  time frames. You are advised to perform your own independent checks,  research or study; and you should contact a licensed professional before  making any investment decisions.

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