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A guide to understanding a Research Report: Part 2

We covered Part 1 previously, describing the basics of a research report. In this Second edition, we go a little bit more in depth.

As previously covered, a research report will include these main components:

  1. Detailed description of the Company and relevant information.
  2. Short write-up on why the analyst thinks the company will do well, or badly.
  3. A one-year target price for the stock.
  4. A rating.

1. Detailed description of the Company and relevant information.

This consists of historical data and information that the public is already privy to or can access. It is particularly useful for investors who do not know about smaller companies, and would like a quick introduction to familiarise themselves with its business before researching further on their own.

2. Short write-up on why the analyst thinks the company will do well, or badly.

Analysts are typically segregated to cover different industries at a research house. They specialise in that industry and would be familiar to companies within the industry. You can look upon them as the in-house specialists.

Most of the time, before issuing a report, the analyst would have a discussion (or informal chat) with the company’s management to understand the general industry outlook, the plans the company have in place, the management quality and the potential of the company. These are done in addition to the company’s financial statement because at the end of the day, the numbers usually speak for themselves.

Often the public would not have such easy access to the management, and this is where information they would not be privy come to the fore more clearly.

3. A one-year target price for the stock.

Analysts have many ways to come up with a valuation for a particular stock. And it is mostly about quantifying the company’s future earnings. Once the analyst has an EPS (earnings per share) forecast in mind, he or she can go about setting a valuation or target price on the stock based on it. Several methods include utilising a P/E (price to earnings) ratio or using the DDM (dividend discount model), among other ways.

4. A rating.

The analyst compares this to the current market value of the stock, and comes up with a rating. And obviously, if the target price is higher than the current trading price of the stock, the rating will lean positively.

Should we believe everything?

For those who frequent stock-trading forums regularly, you may be familiar with the term “DYODD” which means, “Do Your Own Due Diligence”. Should we trust everything a financial report states?

We always bear this rule in mind: If a lunch is free to you, it is designed with someone else’s interest in mind.

We highlighted some of the negative and positive points of financial reports in our previous article. You should never take reports at face value only. Here is a recap of some reasons why, without going into too much detail.

–       Relationships between analysts (or the bank they represent) and the company.

–       Analyst reports would bring to light the company to investors, thus increasing transaction, and thus increasing profits for their brokerage.

–       The rating is very general and not tailored specifically to your investment needs.

Of course analyst reports bring about just as many positives, do check these out in our previous article. For us, we believe that the quantifiable segments of these analysts’ reports are useful, especially when accompanied with peer comparisons.

We hope this article allows you to better understand both the usefulness and limitations of a research report, and that you would be able to better tap on this in your own investing journey. Do follow us on Facebook to stay up to date with articles that could enrich your understanding on investing.

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