Analyst Handbook

Clients will pay us if we make them money or if we

make them smart.
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The Ten Commandments
Develop proprietary opinions based on primary research. Regularly
check with competitors, customers, and suppliers of each of your
companies. Develop unique approaches to financial analysis. Perform
proprietary surveys. Avoid at all costs simply repeating guidance or
management opinions unless you disagree with them.
Be proactive. trive to be the first to market with any new idea or piece of
information!!if we aren"t, our competitors will. All information becomes a
commodity very quickly. #ach analyst should be in front of the
institutional sales force no fewer than two to three times per week.
Be provocative. Playing it safe turns into a loser"s game over time. $t
dulls our senses and results in lackluster analysis with no impact on our
clients.
%ollow and publish regularly on at least &'!&( institutional!quality stocks
with market caps generally in the )*++ million ! )* billion range and with
an average daily volume greater than '++,+++ shares. ,rite all research
with an eye to the institutional market!!it can always be encapsulated for
the retail client.
-aunch coverage on at least one new stock per quarter, pruning
unproductive names from the list as required.
.aintain an above!average stock picking performance. According to a
/elson"s survey, the average ,all treet analyst is right about ((0 of the
time1 our goal should be to be right 2(0!3+0 of the time.
Develop a following with our top accounts. #ach focus account should be
contacted at least once per month. 4his list will be developed with the
sales force and will be monitored regularly.
5ooperate with corporate finance. #very idea generated by corporate
finance deserves our attention, but be sure to operate within the
regulations that require a gatekeeper to be present for most
conversations.
#6pand our relationship with retail. 7nly a small amount of retail8s equity
business is in our names, and it can be much higher with a modest
amount of additional effort. 4reat the brokers that have substantial
positions in your stocks as you would an institutional client9add them to
your contact list. 4alk to April -angel regularly about your stocks, maintain
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an active %ocus -ist, and speak to the entire retail department periodically
about your group and your best ideas. Return all calls from brokers within
': hours. 4here should be regular visits to the branches, with a goal of ( !
&+ visits per year. 4ake company management to the ma;or branches and
arrange field trips to local companies.
<eep trading informed about anything that you think will impact a stock8s
price and any clients who have indicated an interest in your stocks. <eep
tabs on our positions in your stocks. $f you believe that there are events
that will substantially impact the price of a stock in the very near term, be
sure that the desk is either flat or on the right side of the trade, being very
careful not to front run the public disclosure of material, insider
information.
Greenwich Survey Findings
=reenwich Associates regularly surveys clients about what they want from the sell!side
and how they pay us. 4he following results should be used to guide us in developing
our institutional business.
,ho controls commissions has changed radically over the last fifteen
years. ,here it used to be analyst votes that directed about (+0 of
commissions in the mid &>?+s, that has fallen to less than '(0. Portfolio
managers don"t fair much better, accounting for only about *+0 of
commission flow. 4he big change over the last fifteen!plus years has
been the emergence of the buy side trading desks as the leading source
of commissions, now directing almost (+0 of all commissions. 4his
suggests that not only should we focus on our buy side analyst and
portfolio manager counterparts, but we also need to focus on how we can
help our sales traders increase account penetration. $n today"s voice mail
world, our sales traders are the only ones who can get a live person on
the other end of the phone with virtually every call.
4he top requirements for analysts to have credibility with clients haven"t
changed much over the years!!they don"t want the si@@le, and they still
want the steak. 4he top four requirements ranked areA
Detailed industry reports
Detailed financial analysis9not ;ust models
Ability to e6plain recommendations
Detailed company studies
5redibility alone, however, does not get us paid!!it only gets us in the door.
$deas and access are what ring the cash register, with the following being the
most importantA
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Bottoms!up research with strong financial analysis
$deas
Regular follow up
#lectronic access to research!!?(0 name %irst 5all as primary
electronic source
4elephone access to analysts is better than visits
Commission roductivity
7ur productivity measured as nickel business per analyst is below our regional peers
as shown in the following table
$nstitutional 5ommissions Per Analyst B) millionsC
%irst Albany &.(
Danney &.:
Advest +.2
tifel +.2
BBE4 +.(
%erris Baker ,atts +.(
Ryan Beck +.:
4his is not difficult to fi6!!more stocks, larger cap Bnot large!capC, more ideas, and more
impact!oriented calls, and the regular commissions will take care of themselves.
!arket Cap Targets
,e could be ultra competitive at the lower end of the market cap range, but there are
simply not enough funds under management nor enough trading volume in this area to
make it a profitable business longer term. Data as of %ebruary '++: shows that only
about &0 of institutionally invested funds measured by market cap and :0 by trading
volume were in nano! and micro!cap stocks.
ercent "f Total Stocks !kt Cap #olume $nst !kt Cap $nst #olume
.ega B&+ Bil PlusC 2.+0 3'.30 *(.>0 2?.>0 :+.&0
Big B* !&+ BilC ?.&0 &:.:0 '+.30 &3.'0 '(.(0
.id B& ! * BilC &*.(0 3.20 &(.>0 >.&0 &>.&0
mall B*++ .il ! & BilC '+.:0 *.>0 &&.20 :.+0 &&.+0
.icro B&++ ! *++ .ilC &3.20 &.&0 2.:0 +.>0 *.'0
/ano B-ess 4han &++ .ilC *:.:0 +.*0 >.(0 +.&0 &.&0
4otal &++.+0 &++.+0 &++.+0 &++.+0 &++.+0
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At the other end of the spectrum, we could become competitive on a research basis in
the mega! and large!cap arenas, but we do not have the capital to make ma;or markets
or to do block trades in this high!end segment. /et net, we are only able to leverage
our research efforts in institutional commissions and other areas of the business in the
small!and mid!cap segments of the market. ,e do need, however, to follow a handful
of mega! and large!cap bellwethers to establish our industry e6pertise and to facilitate
our vote penetration at large voting accounts.
7ur current mi6 is very reasonable, but somewhat meaningless since we have so few
stocks under coverage. At a &(+!stock coverage level, the targeted mi6 would give us
about &++ mid!, large!, and mega!cap stocks that we need to effectively collect votes
on a broad base, while still being heavily concentrated in the small and mid!cap areas
that will allow us to differentiate our coverage.
Ryan Beck Research 5overage
5urrent .i6 ' !year 4arget .i6
.ega '0 (0
-arge *' &(
.id '( :+
mall *& '(
.icro > &+
/ano & (
!orning !eeting
This is our most crucial interaction with the sales force and trading--without a high-
impact morning meeting, we cannot leverage our research, and ultimately will fail as an
organization.
#very analyst should strive to be in front of the sales force at least two to three times
per week. At first blush, this may seem like a difficult goal, but let"s look at a typical
e6ampleA
4he basicsA 4here are '' trading days in the average month and let"s assume that a
given analyst is following &* stocks Bthe average for all of ,all treetC.
RatingsA -et"s assume that of the &* stocks, one is on the %ocus -ist, seven are
Buys, four are Folds, and one is rated ell.
%requencyA At a minimum, all %ocus -ist, Buys, and ells should have a call two times
per month. Folds can be only once a month.
5ontentA /ot every call has to be action oriented, although the more action the
better. 4he sales force Band the clientsC need to be constantly updated as
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events unfold to reinforce our point of view, and to give early warning of a
change in our point of view.
o, where does this leave us as to the number of callsG
%ocus -ist & 6 ' H '
Buys 3 6 ' H &:
Folds : 6 & H :
ells & 6 ' H '
4otal calls '', or 1 per day for every day of the month.
Why two calls per month on uy!"ell rated stocks# %irst of all, we aren"t doing our ;ob
if we don"t speak with every company we follow at least once a month, preferably mid!
month so that the company has had time to look at its results for the previous month
and may be ready to change its guidance. Assuming you make this minimum level
contact, then you will have something to say to the sales force if it is nothing more than
I$ spoke with management today, and everything seems to be on track.J $t"s really that
simple, and there"s no e6cuse for not taking the high road on this issue.
Kou also get at least two freebie calls on each company near earnings release time!!
first an earnings preview, then a first!impressions call if the company releases results
first, followed by a conference call later in the day, and then the analysis of the quarter.
As to the requirement for two or more calls on BuyLell rated stocks, let"s presume that
you want the sales force to know these stories better than your Fold rated stocks and
that you want them to make regular contact with the clients. 4he only way to
accomplish this is to give them fresh meat.
.ake your mid!month checks with the company and write it up for %irst
5all.
#valuate every news item on the industry andLor the company to see how
it fits with your investment thesis. $f it confirms your thoughts, write it up.
$f it doesn"t, don"t ignore it since your competitors won"t. $f it appears to
be an anomaly, address it as such and take the sales force through your
thought process. $f it might be the beginning of the unraveling of your
position, give the sales force an early!warning call and prepare them with
the signs you will be looking for, either to stay the course or to make a
change.
4ake the time to analy@e ideas that you get from talking with clients. 4hey
may raise a concern that you had overlooked, think a competitor has a
fresher view of the company, or suggest another way to look at a
company. Don"t ;ust do the work for one client!!flesh it out and use it to
increase your impact with the sales force and all our clients.
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Additionally, let"s not forget that our ;ob isn"t done ;ust because we
launched coverage on a new stock. 4he first few months after launch are
the easiest time to get the sales force"s attention since the idea still has
the taste of newness, and they will generally be more receptive to new
data and better ways to deliver the story.
How %ou Say $t $s "ftentimes !ore $mportant Than &hat %ou Say
4he structure of the call is crucial to get the sales force"s attention and to make it more
likely that they will deliver your message to the clients.
%irst of all, base your presentation on your %irst 5all note. $f you have structured it
properly, you have already laid out the call for the sales force. Kour comments should
simply add color and make sure that the sales force understands the importance of the
information. $nder no circumstances should you simply read the note to the sales
force.
4he salesmen and traders have to take what might be a two to three minute
presentation from research and condense it into a *+!2+ second portfolio manager or
trader call. $n order to help in this process, $ would recommend that your presentation
Band to some e6tent, your write upC stay close to the following general formatA
Always start your call as followsA
&C 4he company $8m going to discuss isA
$ts symbol isA
$t closed yesterday atA
'C ,e are changing our rating from MMMMMM to MMMMMM and our '+MM and '+MM
estimates from MMMMMM to MMMMMMM, respectively.
7R
,e are changing our rating from MMMMMM to MMMMMM and reiterating our '+MM and
'+MM estimates of MMMMMMM, respectively.
7R
,e are changing our '+MM and '+MMestimates from MMMMMM to MMMMMM,
respectively, and reiterating our rating of MMMMMM.
7R
4his is an information call that lends further support to our investment thesis
which is MMMMMMMMMMMMMM.
*C 7ur price target for the stock is MMMMMM.
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:C 4he principal reasons for these changes areA
&C
'C
*C
:C
(C
NEVER, NEVER, NEVER have more than five points in any call, and try to keep
it to three.
(C 4his isLis not proprietary information. $t was obtained from a general meeting,
private conversation, proprietary analysis, etc.
2C As a result of these changes, $ now appear to be in line with consensus...
7R
As a result of these changes $ now appear to be at odds with the consensus of
MMMMMM because......
3C 4he stock8s recent trading has been characteri@ed by Bif there is any significant
change in its trading patternCA
By providing a handout and a discussion format that is user!friendly, you will be
positioning yourself for more broad!based and effective sales and trading follow
through on your morning meeting comments, as well as greater visibility with your
clients.
First Call
%irst 5all is by far the best way to leverage our research efforts and takes priority over
all other production and distribution efforts.
%irst 5all has the widest distribution, appearing on well over *+,+++
individual desktops worldwide. $ts data base contains almost &+ million
documents, so we have to be quick, punchy, and insightful in order to
battle for mind share.
5lients view %irst 5all as their primary and most important source of
information. A recent survey by =reenwich Associates found that
electronic distribution was the most important means of obtaining
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information, with about ?(0 naming %irst 5all as their preferred source for
obtaining research.
According to a recent %irst 5all survey, the five most important items in
their data base are displayed in the following list. ince we control the
content and timeliness of four of the five items, there is no acceptable
e6cuse for not being at the top of our game in giving customers what they
want.
#arnings estimates
Analyst recommendations
Revenue estimates
5ompany pre!announcements
=rowth rates
Kou can get your message out even if an individual salesperson decides
to not make your call. /ot all of the sales force will embrace all your
ideas due to different client requirements for market cap, sector focus,
investment goals, and so forth. %irst 5all is the great equali@er.
,ith such a large dependency on %irst 5all by virtually every ma;or and
regional brokerage firm, it is crucial to format research notes for ma6imum
impact. %irst 5all surveys tell us that the average client spends only &+!
&( seconds scanning the note, so the following approach is critical.
4he title should always begin with the stock symbol, followed by a
catchy headline.
4here should be a minimum amount of numbers.
4here should be three to five one!line bullets that tell the entire story
and that can be read in ten seconds.
4he bullets are not enough, however, and they must be followed by
some real, insightful research!!not ;ust reporting!!written in a clear,
concise form.
%irst 5all notes must be posted by ?A++ a.m. to have any impact. 4his is
particularly important for mid! and large!cap stocks since the surveys suggest
that clients only read the first four to five notes that come across their
systems on a stock on any one day. 7bviously, breaking news during the day
that requires a note can"t meet this requirement, and these notes should be
posted as soon as possible.
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7ur goal is to be in the top ten brokers every quarter as to timeliness and
quantity of %5 notes per stock. 4his generally means 3(0 of all %5 notes
published before >A*+ and :!( %5 notes per stock per quarter.
'asic (eports)!a*or +pdates
There have been several surveys over the last few years that clearly suggest that we,
as research analysts, must do everything in our power to make our written product as
easy to use as possible, or it will be relegated to the scrap heap. The key points from
these various are%
A portfolio manager will spend only '+!*+ seconds on the first page of a
research report to decide whether or not to read it.
$f a P. decides to read a report, he will on average read only the first
three pages.
Research reports should generally fall into three categoriesA
&!* pages!!distribute only on %irst 5all
:!2 pages!!always include quarterly earnings models
&+N pages!!targeted at analysts and crucial for large voting accounts
Based on this input, we will put in place the following array of productsA
The "treet produces about &'( pages of company research per analyst per year. This
does not include industry updates, weekly!monthly overviews, and so forth. )ur focus
on deliverables should be to improve our timeliness and quantity of reports while
improving the content.
,ithin the conte6t of writing research reports that address both portfolio managers and
analysts, the following guidelines should be observedA
/ew coverage should be launched with a report that is detailed enough to
tell the story including growth prospects, market segmentation,
competitive position, risk factors, valuation analysis, and a financial
forecast. $t should contain at a minimum a detailed quarterly forecast for
the ne6t two years. /ew coverage can be launched with either a short
report that covers only the highlights of the story or a long report that
addresses all the issues e6pected in a complete company report. 4he
approach chosen by the analyst should take into account several factors,
including the comple6ity of the story, the ability to turn around a complete
report quickly, the action in the stock, pending news, and so forth. $n
general, coverage should not be launched until a first draft of the
complete report is in the editorial process.
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-aunching coverage on a new industry or a new sector within a current
industry should be done with a Ofranchise buildingO report that provides in!
depth industry analysis as well as our normal detailed company analysis,
hopefully on two or more companies. 4his both establishes our credibility
with investors, and provides the building blocks for the franchise.
Regular updates should be published as events unfold, but no less
frequently than once per quarter when financial results are released.
tocks that are being actively recommended or that are seeing high
trading activity need more frequent written updates so that the sales force
has fresh material with which to work. All updates should include at a
minimum a detailed quarterly financial forecast.
$n general, comments from the morning meeting must be documented,
unless they are simply responding to news in the paper, comments from
other firms, response to questions, daily trading recommendations, or a
reaction to changes in stock price.
All earnings andLor ratings changes must be detailed in a report that
includes the reasons for the changes and a detailed quarterly forecast.
,e will need to produce a monthly report that highlights our coverage.
4his is used primarily as a marketing tool by the institutional sales force
and has minimal investment impact.
Research Report Structure
*f one were to ask five different analysts and five different salespersons about the right
way to write a research report, there would surely be ten different answers. The only
way to get our arms around this question is to ask our clients--not a dozen at random,
but hundreds of clients. +rudential "ecurities did e,actly that a few years ago, so we
don-t have to reinvent the wheel. They hired an outside consultant who interviewed
over .'( clients /weighted about &!. portfolio managers, 1!. buy-side analysts0. The
outcome of the survey is summarized below.
&ho,s The Audience-
4here are many right ways to write a research report, although two questions should be
answered by the analyst before it is publishedA
,ill $ get a portfolio manager8s attention with the first pageG
Fave $ supplied adequate added value for an analystG
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$f the answer is yes to both questions, the internal structure should be fle6ible and
adapted to the specific situation!!a stable growth company will certainly have a different
focus than a company recovering from a weak period. /ot all reports will cover the
same sub;ects!!in some cases, competition may be an important factor, in others it may
be new products or an analysis of recent acquisitions. $n all cases, however, your
investment thesis must be laid out up front and address your recommendation, price
target, conclusions, and the foundation for your conclusions. Any risks should also be
spelled out.
Reports do have two very different audiences!!portfolio managers and analysts. A
report focused on only one audience may never be read by the other. 4he following
discussion is a summary of ideas about how to write for both audiences!!in most cases,
the ideas are only suggestions, but the portfolio manager structure is e6tremely
important if we ever e6pect him to read our reports at all.

ortfolio !anager
4he key problem with the P. is to grab his attention and to get him to at least read our
investment thesis. 4his requires the followingA
4he industry sector should be prominently displayed on the cover.
$f the stock is small! or mid!cap or international, there should be a very
brief description of the company on the cover.
4he rating on the stock must be prominently displayed on the cover of the
report.
4he investment!related story must be prominently summari@ed in two to
five bullets on the cover. $f he gets past this level, he might read the first
two or three pages of the report.
A summary earnings forecast should be on the cover. $t should include a
two!year forecast, the PL#, dividend, shares outstanding, market cap, and
so forth.
4he investment thesis and analytical foundation for our investment
conclusions should be spelled out starting on the cover. A catchy
headline can be useful in gaining attention and should be directly tied to
the investment conclusion.
4he investment opinion section should address the followingA
$t should state your recommendation and outline the most important
reasons for it, such as a forecast that deviates from the consensus, a
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point of view that differs from most observers, a mis!valuation of the
stock, etc.
$t should have a Owhat if things go wrongO section.
$t should summari@e your valuation assumptions and present a target
price.
$t should address the ma;or assumptions in your revenue and earnings
forecast.
4he analyst8s name, email address, and telephone number should be
prominently displayed on the cover so that the P. can reach the analyst
without fumbling through the report to try to find the author.
$f you have grabbed the portfolio manager8s attention by this point, he
may skim the report. Fe won8t read very much, however, so there should
be a liberal use of headings andLor comments in the margins that tell the
story even if he doesn8t read a single word of the te6t. 4his is also true of
headings on tables and graphs!!they should tell the story in the table
such as O#arnings hould 4urn Pp in the %ourth Quarter,J and not ;ust
state something like OQuarterly #arnings %orecast.O
Analyst
4he buy!side analyst has a very different set of requirements than the portfolio
manager. ,hile the same structure mentioned above is helpful in getting his attention,
he generally wants data more than he wants an opinion. 4he general topics that should
be covered include B&C a company profile that e6plains why the company is successful
Bor unsuccessfulC, B'C divisional or product line breakouts, B*C a discussion of
management, B:C a detailed financial forecast, B(C a valuation analysis, and B2C for some
industries, a discussion of regulations.
$n general, there is no such thing as too much data or too much analysis. =raphs and
charts can be helpful in telling a story, but the raw data is usually even more important
since most analysts have to write their own reports and normally don8t have the time to
chase down the data with which we routinely work.
Company Profile
,hatever else this section does, it must address one key issueA 1ow does this
company make money# Does it sell performance, hopes and dreams, or the better
mousetrapG ,hat have been the keys to its success!!do one or two products andLor
services account for the ma;ority of its businessG ,hat products are the key to its
futureG
Among the other basic questions are the followingA
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Fow well does it do in its basic businessG $s it growing slower or faster
than its industryG $s its success tied to the market in which it operates or
can it stimulate new demand in other markets andLor geographiesG $s it
early to market with new products or is it a Ome tooO companyG
,hat is its competitive positionG $s it gaining or losing shareG $s its
market in its infancy or is it matureG
,hat are the key determinants of financial performanceG ,hat are the
key levers for the future!!revenue growth, market share, e6pense control,
e6pandingLcontracting margins, financial leverageG
,hat are the company8s near!term and long!term goals!!product,
markets, growth, financialG
$s the company planning to diversify its businessG Fas it done it before
and was it successfulG $s it planning acquisitionsG Fas it successfully
acquired businesses beforeG
$s it e6panding geographicallyG Are its international operations growing
faster than the P..G Are they as profitableG
$n a regulated industry, what is happening in ,ashington and at the
stateLlocal levelG
Divisional/Product Breakout
4his section should focus on the ma;or divisions andLor the ma;or product lines in each
division. At a minimum, it should address the sales and earnings growth of the
company8s divisions and geographies as well as the revenue of its ma;or product lines.
%or each ma;or divisionLproduct line, it should also considerA
,hat is the range of forecasts by product line for sales, margins,
profitabilityG Fow is profitability tied to changing volumesG ,hat impact
does product mi6 have on overall profitabilityG
,here are the company"s products manufacturedG $s there any currency
impactG ,hat changes have there been in material costs, labor, fuel,
overhead, etc.G
Are RED e6penses increasing or falling rapidlyG $s there a substantial
change in RED planned for new productsG Are abnormal e6penses being
incurred due to opening new plants, changes in product line, etcG
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,hat can be learned from the company8s customers, suppliers, or
competitorsG Are its products being challenged by new competitors, new
technologies, or new business ideasG
ana!ement
,hile this is sometimes not particularly important for very large!cap stocks, it is crucial
for small! and mid!cap companies. 4his section should address those issues that are
central to your investment thesis!!simply naming the management and their e6perience
generally does not add much value.
Fow is the company structuredG Do the structure and compensation
programs provide adequate incentiveG Are there controls to reduce
unpleasant surprisesG
,ho are the key managementG ,hat is their e6perienceG Fave they
done this beforeG ,hat are their ages and compensationG Do they own
much stockG
Fow deep is its understanding of the markets in which it operatesG $s it
on top of competitive trendsG Fow does it deal with changing economic
trendsG $s the past performance of the company the result of current
managementG
,hat is the management8s ability to forecast its business and to control
its manageable costsG ,hat are its assumptions about future trendsG
Are they reasonableG
Are current problemsLerrors being glossed overG
$s management concerned about good relations with investorsG $s
management8s image being accurately communicated to investorsG
Earnin!s "orecast
A short!term quarterly forecast Bthe previous, current, and ne6t fiscal yearC
including year!to!date results should be made. Pro;ections should show
complete quarterly income statements with a discussion of each ma;or
component of the pro;ection.
A long!term annual forecast should be made. $n addition to the normal
income statement, it should consider the followingA
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$t should analy@e the trend in sales, margins, earnings, etc., with
accompanying rationale. ,here possible, it should be made by line of
business. $f growth is accelerating or decelerating from the historical
trend line!!whyG 4he discussion should consider changes in the
company8s ma;or markets, its competition, new products, changes in
e6pense structure, etc.
Patterns in sales and earnings should be discussed. #conomic
impact, product cycles, unusual developments, etc., should be
analy@ed.
5onfidence levels of your forecast should be discussed, both relative
to the trend as well as to year!to!year forecasts.
Quality of earnings should be discussed. 5onsider the followingA
Are reported earnings changes coming primarily from operations, or
are changes in other income, ta6 rates, shares outstanding, etc.,
unduly affecting reported resultsG
$s the reported growth being generated internally, or is it coming from
acquisitionsG ,hat is the internal growth rateG
$s financial reporting accurately reflecting the sustainable earnings
powerG Fow are inventories, receivables, pension accounting, ta6es,
etc., affecting reported resultsG
,hat is currency translation doing to its competitivenessG 4o its
reported resultsG
,hat is the potential of dilutive equity offeringsG $s the company
repurchasing its sharesG
"inancial Position and Capital Re#uirements
4he balance sheet and cash flow analyses should focus on those items
that are key to your investment thesis and should include quarterly
forecasts if they are required to support your investment thesis. 4his
analysis may include the followingA
Fow realistic is the balance sheetG Are assets or liabilities overstated
or understatedG Fow have acquisitions influenced the balance sheetG
Does a ratio analysis!!inventory turns, D7, current ratio, capital
turns, etc.!!provide any additional insights into the companyG
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,hat is the debt levelG $s it affected by short!term swings in interest
ratesG ,hat are its repayment obligationsG Does it have adequate
cash flow to cover themG
,hen will it run out of cashG $s it more likely that it will raise debt or
equityG ,henG At what rateG
Does it pay a dividendG $s it likely to be raisedG 5an it afford itG
A return on investment analysis is often very revealing. $t should include
an analysis of capital turnover, return on total capital Bpreta6C, return on
equity, and a measure of financial leverage.
Valuation
Raluation analysis can differ widely by industry sector, market
capitali@ation, and growth rate. $t should be considered carefully, for there
is rarely only one answer toA What should the stock sell for#
,hat is the basis for your valuationG hould it be ;udged by relative
PL#, absolute PL#, PL# to growth, priceLsales, priceLbook, etcG
Fow does it sell relative to similar companiesG Relative to its
historical patternG
Fow have changes in the market, interest rates, competitive situation,
economic developments affected its valuation relative to its historical
levelsG
Fow would you rate its stability, quality of earnings, growth rate,
profitability, etc., relative to its peers and their relative valuationsG
,hat are the dominant trends in investor psychology and the structure of
the market that could influence your conclusions from aboveG
,hat is the resultant price targetG
roduction Targets
,hile each analyst will develop his or her own approach to generating business,
publishing our research is the cornerstone of our business. $t not only increases the
trust of the sales force and clients as well as opening doors to other potential business,
it makes you a better analyst.
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$n many respects, publishing is for the analyst, not for the reader. $t makes you think
and should result in new ways to look at a company or your industry sector. $t tests
your models and forecasts. $t tells you whether your valuation techniques and resulting
price targets make sense. /et net, it tells you how well you are doing your ;ob.
,hile the following are only guidelines, $"m always hard pressed to understand how
some analysts think we can generate substantial commissions with anything lessA
2irst of all, if it is worth talking about, it is worth writing down. $f it is worth
writing down, it is worth posting on %irst 5all. $f it is worth posting on %irst
5all, it is worth getting it there before ?A++ a.m. so it has some impact. And if
it is worth all this effort, it is worth e6panding into a published report!!
something meaningful!!not ;ust the two to three bullets and a handful of
paragraphs from the %irst 5all note.
There should be a goal to launch a new company every quarter, trimming
unproductive stocks to make room. 4hese reports should be complete and
insightful as described earlier.
There should be ma3or updates at least once per year on your best ideas!!it"s
hard to convince the sales force and clients that you are up to date on all the
issues if you never publish any fresh, ma;or research.
There should be a report published every time you change ratings, change
earnings outlooks, or there is a ma3or event with one of your companies. A
one to two page report is usually not enough.
4arnings previews are required on all your companies. 4hese can be short
unless you are making changes to estimates or ratings. 5ombining these
into a single report that is published two to three weeks before the first
company reports is an efficient approach, and you may want to consider
following up with a brief %irst!5all!only note the day before results are due.
*t is absolutely mandatory that we respond quickly to all earnings reports--
there is no e6cuse for not having a %irst 5all note within hours after earnings
are released, and the published report should be out the ne6t day.
*ndustry reports are crucial in convincing clients that we really do know what
we are talking. 4his is always the best approach to use when launching
coverage on a new sector, and is particularly effective when launching
coverage on two or more stocks simultaneously. $f your industry does not
lend itself to at least a quarterly report, consider a periodic overview, focusing
on one or two ma;or issues.
5indless monthlies /quarterlies0 are 3ust that--mindless. Repackaging your
%irst 5all notes or short reports with a few statistics offers no added value to
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anyone, nor does simply regurgitating a handful of government statistics.
.ake these reports into full!blown industry reports or don"t make them at all.
#aluation)rice Targets
$n general the treet has gotten la@y in doing its valuation work and setting price
targets. .ost research today simply asserts a valuation such as Ithis stock should sell
at a &+0 premium to its peers,J or Ithis stock should sell at a '+6 PL#.J ,hile these
statements may in fact be true based on your analysis, it is inadequate to simply make
an assertion without the analytical backup. 4here are several good approaches to
valuation analysis such asA
Build a table of comparable stocks, highlighting the valuation techniqueBsC
you think are most appropriate such as PL#, PL#!to!growth, cash
flowLshare, enterprise value, etc.
Present a graphical history of how the stock has traded using such
approaches as PL# bands, relative PL# bands, etc.
Pse a generally accepted mathematical approach such as the formula for
target PL# based on a company"s growth rate versus that for the EP.
4his is one of my favorites since it is rarely used and is always
provocative.
Devise your own proprietary approach. $ once worked with an analyst that
had a very convincing analysis that the price of Deere, 5ase, and other
farm equipment producers closely followed the price of corn.
$n any event, do something thoughtful that will help the sales force believe in your story
and help clients look at the world through your eyes. .ost important, do it for yourself!!
sometimes you will be surprised how far from reality your targets are when put under a
microscope.
etting target prices, however, also needs a time hori@on to make them effective. 4his
will derive from a combination of your own style!!are you a deep value or earnings
momentum analyst by nature!!and the predictability of the stock and its earnings. 4ime
hori@ons for technology stocks should probably never be more than si6 months unless
you are a masochist, while looking out &'!&? months is common for packaged goods.
5onsider the followingA
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5arefully look at the predictability of your industry sector and the inherent
volatility of the stocks. <eep your time hori@ons in line with both. 6ever
pro3ect price targets beyond your ability to forecast.
#valuate the impact of outside events on your sector and your ability to
predict them. %or e6ample, interest rates and consumer debt play a ma;or
role in the earnings performance of consumer finance companies. ,hile
you can track this data using government reports, how comfortable are
you that you can predict interest rates at various parts of the business
cycleG ,ould it make more sense to have a &'!&? month hori@on early in
the business cycle, cutting to only si6 months when the cycle is getting
long in the tooth and worries about interest rate hikes are mountingG
$s your sector inherently cyclical or stable growthG Fow good are you at
calling turning points in the automobile cycle and are your models
adequate to measure the huge impact of modest changes in revenue on
operating income when an auto producer is hovering around break evenG
,e all have our favorite valuation techniques, but it is crucial to give clients something
they can use and to evolve our techniques as client requirements change. 4he
following data is from a survey of '* of the *+ largest commission producing accounts
in the P.. and should be used as the starting point for your decision as to what
valuation techniques you want to use.
Demographics
230 Portfolio .anagers
&'0 Directors of Research
'&0 Analysts
Raluation 4echniques Psed B&*( ResponsesC
>+0 Absolute1 &+0 Relative
:?0 PL# Related
**0 5ash %lowL#nterprise Ralue Related
&'0 PLBook Related
&+0 7ther
Ranking of All Responses
P/E-To-Growth 20%
P/E 19
EV/EBITDA 12
P/B 11
EV 11
21
P/S 6
R! P/E 6
EV/E-To-R"E 3
R! EV/EBITDA 3
#r $%&h #!ow 3
P/$E 2
R! P/B 1
EV/EBITDA-To-
Growth
1
'(!) 1
D$# 1
Tot%! 100%
4he above table clearly demonstrates that a one!si@e!fits!all approach to valuations
and targets is not appropriate. $t also clearly points out that relative valuation
techniques are no longer the norm, and if we want to improve our impact on most
accounts, we should focus on absolute techniques. 4his is not to say that we should
abandon relative PL# and other similar techniques, but that we should know the client
and tailor our discussion to meet its needs.
The A'Cs of Supervisory Analyst Approval
,riting research to meet P.. regulatory requirements is very simple!!there are only a
handful of rules that we have to adhere to, and by so doing, your research will be
produced with virtually no time lag. 4he rules are as followsA
./ %ou must be careful to not make promises or guarantees.
BadA I...the stock will trade up to &'+...J
I...sales will increase by &(0 this year...J
I...margins will improve when the new plant opens...J
=oodA I...in our opinion, the stock could trade up to &'+...J
I...we estimate that sales will increase by &(0 this year...J
I...margins should improve when the new plant opens...J
$t"s ;ust that easy. Adding Iin our opinionJ or Iwe estimate thatJ will take care of
most offending promises. $n many cases, simply using the word IshouldJ instead
of the word IwillJ will also fi6 the problem.
0/ Forecasts and estimates must be clearly indicated as such.
4his is really simple. All you have to do in tables and charts is append the letter
I#J to all forecasts and estimates. $n most cases, this will simply be the heading
of a table or the labeling of a chart such as 01123.
22
4/ There should be no claims as to your stock picking performance.
$t is virtually impossible to meet all the /ew Kork tock #6change requirements
to make performance claims, so avoid them at all costs. $t is 7<, however, to
specify a stock"s performance from an arbitrary outside event or date.
BadA I...the stock is up '+0 since we recommended it...J
I...the stocks on our recommended list outperformed the market...J
=oodA I...the stock is up '+0 since the first of the year...J
I...the stock is up &(0 since the sector bottomed late last year...J
I...the stocks in our universe have outperformed the market...J
2/ The price of any stock must be included in a report where there is an
investment opinion.
ince many statements could be deemed to influence an investor"s opinion even
if we do not have a rating on the stock, the easy way out is to provide the price
the first time any stock is mentioned in a report.
=oodA America 7nline B)(' &L:C
BetterA America 7nline BA7-!!)(' &L:C
BestA America 7nline BA7-!!Buy!!)(' &L:C
An alternative is to list all the stocks and their prices at the end of the report,
although this is not as helpful for clients who seem to prefer seeing the price
while they are reading about the stock.
5/ %ou must not use inflammatory language or make e6aggerated claims.
Kou cannot say things like I...this is the best story $ have ever seen...J or I...this
stock will set new standards for performance...J Kou must be particularly careful
not to use language that encourages speculation by saying things like I...this
stock is unattractive on fundamentals but is interesting as a speculation based
on takeover potential...J
7/ %ou must not create or pass on rumors.
Kou may comment on rumors that have already been publicly discussed in the
media or on the tape with a view to providing additional information, confirming it
or refuting it based on company information or your independent analysis, but
you must not fan the flames.
8/ All data in tables and charts must state its source.
Another really simple requirement..all you need to say is the followingA
ourceA 78o estimates and company reports
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ourceA 9epartment of 8ommerce
or whatever is appropriate as the source of the data.
Client Calls and Client #otes
$t is e6tremely difficult for the firm to get a substantial number of client votes until we
have appro6imately &(+ mid!, large!, and mega!cap stocks under coverage. 4his is not
to say that we shouldn"t focus on accounts where we can make a difference, but a
broad!based client calling program would not generally be a good use of our time at the
moment. ,e will develop with sales a very focused target list of accounts, however,
where we can make a difference and your counterparts in these accounts should be
contacted at least once per month.
,hile our e6pectations for votes will remain modest until our coverage list is
rebalanced, the information that you get from the clients can be invaluableA
Kou will develop a handful of relationships that you can use to bounce ideas
off of and to fine!tune your analysis before you take it public through the
sales force.
By talking with clients regularly, you will always find new ways to think about
issues, find holes in your research, and tap many une6plored areas where
you can make an impact by beating your competitors to the punch.
By speaking with your best clients!!friendliest!!first, you can fine tune your
pitch and have more and more impact as your client list grows.
Kou will be able to learn what your competitors are thinking and oftentimes
can get early warning on changes in thinking about a stock or sector before
there is general awareness, thereby, giving you some lead time to ree6amine
your analysis and have additional conversations with the company.
9ealing &ith The ress
The press is your friend if you use it correctly.
%ind out who your counterpart is at the ,D, Dow Dones, Reuters, Bloomberg, and
5/B5 at a minimum. =et their telephone number, %AS number, and e.ail address,
and use them.
5allL%ASLe.ail them every time you have an important message on a visible stock.
4he priority is %irst 5all, salesLtrading, Dow Dones, Reuters, Bloomberg, 5/B5, client
calls, ,D, or other print media. ,hile this may seem somewhat backwards at first,
individual client calls are the least leveraged while %irst 5all and salesLtrading are the
24
most leveraged and most focused. Dow Dones, Reuters, Bloomberg, and 5/B5 have
terrific impact, but we lose the proprietary impact on targeted clients if we go there
before %irst call and salesLtrading..
Felp the press do their ;ob and you will be ama@ed how much they will help you do
yours. 4hey are a tremendous source!!particularly the print media!!for what is going on
in companies and will regularly ask for your views on what it means if a company is
thinking about doing an acquisition, adding a product line, and so forth, oftentimes well
before anything is announced publicly.
$n dealing with the press, you must think in sound bites!!you only get one chance to be
included in an article or interviewed on 5/B5. Kour %irst 5all bullets are the best place
to start, but ;a@@ it up if necessary. ,ith a proper sound bite, your quotes will both be in
the first and last paragraphs of a written piece by the ,D or Business ,eek or will be
the lead in a news story over Dow Dones or Reuters.
$f you are asked a controversial question, and you feel flustered, tell them you are busy,
ask for their deadline, and tell them you will be back to them in plenty of time to make it,
take a breather to collect your thoughts and A-,AK call back.
%ind your counterparts in the trade press and A-,AK be helpful!!this is critical to
building brand name recognition for yourself as well as the firm and is a crucial part of
building the franchise.
Put the press on your mailing list!!both financial and trade press. Kou will be surprised
how often a piece of your research will turn into the basis of a feature story, particularly
in the trade press.
Analyst)Sales #ote
#very si6 months we will ask sales to formally evaluate our performance in several key
areas Bsee attached sample formsC. ,hile the results will not be used directly to
determine bonuses, they will be used to help focus our attention on areas where we
need improvement as an organi@ation, and more importantly, as individual analysts.
,e will also ask the analysts to formally evaluate the sales force on the same schedule
so that they can also become more effective in working with research.
4he details of the votes will be kept strictly confidential, and only summary information
on their own performance will be available to individual analysts and salespersons.
25
Sample (esearch #ote :'y Sales/
DateMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMM
Analyst"s /ameMMMMMMMMMMMMMMMMMMMMMMMMMMMMMM
$ndustry <nowledge MMMMMMM
5ompany <nowledge MMMMMMM
$dea =eneration MMMMMMM
4imely Documentation MMMMMMM
ense of Prgency MMMMMMM
A.LP. 5omments!!Quantity MMMMMMM
A.LP. 5omments!!Quality MMMMMMM
Portfolio .gr. $mpact MMMMMMM
coringA & H Poor, * H Average, ( H #6cellent
alesperson"s /ameMMMMMMMMMMMMMMMMMMMMMMMMMMMMMM
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Sample Sales #ote :'y (esearch/
DateMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMM
alespersonMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMM
Pnderstands .y $ndustry MMMMMM

Pnderstands .y 5ompanies MMMMMM
,illingness to ,ork with /ew $deasL5oncepts MMMMMM
.akes 4imely 5alls with $mportant $nformation MMMMMM
ets Pp Appropriate 5lient 5ontactsA
-ist of 5ontactsLPhone /umbers MMMMMM
5lient Risits MMMMMM
5ompany .anagement Risits MMMMMM
Provides Pseful %eedback from 5lients MMMMMM
& H Poor, * H Average, ( H #6cellent
AnalystMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMMM
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'usiness lan
#very analyst Band ;unior analysts getting ready to launch coverageC will be asked to
provide an updated business plan every si6 months. ,hile the plan will not be used
directly in figuring compensation, it should become a critical part of each analyst"s
thought process about how he wants to run his business and how he wants to be
measured.
4he plan will focus on coverage, votes, production, client contacts, working with
corporate finance, retail commissions, and press contacts. A spreadsheet will be
provided to assist in generating the plan and results will be formally reviewed during
performance reviews to measure each analyst"s progress against the goals that he
sets.
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