Equity research is the study of a business (and its industry or sector) in order to provide a recommendation to investors to buy or sell shares. This involves extensive analysis of a company’s financials.
There are generally two categories of equity research: buy side and sell side. Buy-side equity research is generally prepared in order for a firm — usually a private equity firm — to validate the decision to invest in a company. Sell-side equity research, which an investment bank’s analysts typically perform, often covers a set of companies within a sector, to suggest that the firm’s clients either purchase or sell shares. An acquiring company can also independently perform equity research when considering a prospective deal, in order to determine the price at which to bid for the securities or assets of the target company.
The following areas are of key interest to equity research analysts.
Perhaps the most important component to equity research is the analysis of a company’s financials. This also requires a thorough understanding of accounting principles and an evaluation of the company’s balance sheet, income statement and cash flow, in addition to how the company values its equity.
Equity analysts also look at both the book value and market value of a company. The book value is the difference between assets and liabilities on the company’s balance sheet, while the market value, as its name implies, is based on the current share price of the company’s stock (if the company is public) or a metric that valuation professionals determine.
Book Value of Equity
Equity, always listed at its book value, is determined by the rather straightforward balance-sheet equation: equity = assets – liabilities. A company’s valued assets include those that are current, noncurrent, physical, intangible, operating and nonoperating. Liabilities include debt and obligations, such as lines of credit, accounts payable, short and long-term debt and leases.
Market Value of Equity
Equity research analysts are also interested in the market value of a company because it can serve as another test or yardstick for valuation. Because accounting statements rely on a company’s past results, analysts use the market value as a way to forecast what they believe the financial performance of the company will be. This helps investors predict future performance.
The market value of the equity is calculated by simply multiplying the latest share price (if public) by the total number of shares outstanding. Private company valuations are more difficult but they do rely on industry knowledge and perception of the company’s value.
Disclosures are warning signs that could potentially impact the company’s future performance and, of course, its value. Legal challenges, debt, liabilities and financial commitments usually fall under this category.
Equity analysts almost always include industry analysis in their reports because it gives investors a better idea of the legal, regulatory and competitive environment in which the company under review is operating. Understanding trends can help provide an idea of what the company’s future revenues or challenges might be.
Projections help investors to better understand what the company’s performance might be in a given amount of time. Investors have different needs and requirements for their portfolios, and projections — based on audited financial results combined with tested, proven models — give them a stronger sense of how their investment in the company might perform.
How CapLinked Helps Investors
In preparing their reports, equity analysts might use widely available data, such as those for publicly traded companies. However, equity analysts, especially on the buy side making recommendations for small groups of investors, might need exclusive company information that must be kept secure and private.
As such, they require a solution to manage the flow of document sharing and reviewing in a safe environment. Virtual deal rooms from CapLinked facilitate due diligence and document review for transactions in the areas of mergers and acquisitions, private equity and venture capital, supporting bankers, lawyers, accountants, investors, consultants and company owners with the accessibility and security they need.
Jake Wengroff writes about technology and financial services. A former technology reporter for CBS Radio, Jake covers such topics as security, mobility, e-commerce and IoT.
Accounting Tools – Equity Research Definition
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