This is as far as I know a unique book. It's in essence a number of check lists covering most aspects of the work description of a sell side equity analyst. The book aims to cater to both the buy side analyst and the sell side analyst. In reality it is the later who is in focus. This is no surprise as the author has been a top ranked sector analyst at a number of US investment banks including Morgan Stanley. According to the author the craft of equity research lacks quality control processes. The profession is mostly learnt through on the job training in a kind of mentor-apprentice-system. You might get lucky and have a good mentor, but on the other hand you might not. Valentine's aim with this book is to develop a best practice for the profession.
The book covers a number of topics such as influencing your research coverage, handling relations within you own organisation and with clients, finding insights to include in research, stock valuation and how to best communicate the research done. Valentine is writing a number of lists of things that often is quite intuitive and basic. The list form is hardly the recipe for a colourful writing and as the same advice is repeated in both the check lists and the text surrounding those lists there is a fair amount of repetition.
There is much in this book that irritates me. However the coverage of topics is comprehensive and I would agree that they probably are close to a best practice for the profession. The advice in this book will both be a good guide for a less experienced analyst and it will remind the more seasoned analyst that he perhaps has neglected one or two aspects of what he could do. There is some good advice regarding psychological pitfalls, too few analysts utilize statistical analysis in the way the author suggests which is a shame and there is also a useful discussion around the best way to build financial models for the companies covered by the analyst.
For an investor, outperformance in the stock market is accomplished by either doing something different from others or by acting like most others but being cleverer than they are. This is a best practice for those who have accepted the professional role as it is, i.e. for those who will run with the crowd. The time horizon for the work of a mainstream US sell side equity analyst is one to six months. With a horizon like that, relative stock performance within a sector is driven by changes in company specifics that are not appreciated by consensus and there is a need for near time triggers. The intrinsic value of the stock is less interesting as valuation is slow-acting.
Here instead, value is something relative within the sector covered. First choice for valuation is to assign a pro cyclical single period multiple to the near term estimate. Growth is seen as the primary reason for differences in multiples, notwithstanding that the spread between return of capital and cost of capital is equally important. Many analysts have a deep knowledge of the companies covered but they are simply momentum analysts.
The author's way to try to create alpha, while at the same time doing the same thing as everybody else, is through focus on three to four key variables. This is the best advice of the whole book. There is no chance you can win by knowing more details than other investors on every topic. There is much to gain from understanding what the key issues for the stock are and then dig deeper around these and recognize the rest of the information is non-important noise.
This is a cookbook to produce the short-sightedness of today's Wall Street, but it is also a unique guide for the person working as a sell side analyst. If you are one, or aspire to be one, you really should read it. I would.
This is a review by eqtbooks.com
This guide provides you many broad categories you need to think about on an equity research job, such as time management and interview skills with companies. However, just reading this book will not make you good at doing those things. It is not the kind of "knowledge books" filled with detail, examples and historical contexts. Instead, it is more like a step-by-step guide. Overall, it is a good book to be kept on the desk for reference.
As a contributor at Seeking Alpha and an amateur analyst I like to read and learn about investments. The book Best Practices For Equity Research Analysts also helped me with things that I was not aware of. Especially Chapter 14 I found very interesting to read. It's called: Identify Yellow Flags Through Forensic Accounting. This topic is also interesting for normal investors who like to do desk research.
James J. Valentine did a great job with this book and I would suggest everyone who is learning to be an equity analyst or who is studying for CFA, but also who likes to read more about investing to buy this book. It's a valuable book that belongs in the study room and on the bookshelf.
I thought this book was informative and was a good overview of much of the material on valuation, due diligence, and behavioural finance contained within the CFA curriculum. The author's own experiences surely added more depth to the material.
I would suggest that future editions contain a disc or web access to go into more detail on sections (autocorrelation in residuals, time series, etc..) and provide non analysts with the opportunity to run through exercises.
Or consider exercises on one long valuation throughout the book running from top down, bottom up selection of sector and company. A fictional interview with management, running a history of numbers, forecast earnings..come up with various price multiples..and finally making a recommendation.
I think that would give readers a more interactive experience and help to use those many Excel tricks.
On the whole, I extracted some value from this book.
My friend Tom Brakke, liked this book and said I would too. He was right, and soon afterward, I heard the author speak at the Baltimore CFA Society. Hearing James Valentine speak is an advantage here. He summarized what is most important, which if you are reading the book, it would be chapter 20 (out of 27). It is his FaVeS framework: Forecast, Valuation, and Sentiment, in that order of importance. Remember that as a key to the book if you read it; it tells you what to focus on as an analyst.
Another key, since the book is long, is to look at the shaded summaries which are usually at the back of each chapter. If stretched for time, read those first, and then read the chapter if you didn't get it.
This book aims to focus analysts on information that matters. Aim for information that makes a difference, and that few others have. Create an information web that maximizes the value of your time, and creates value for your research.
This book covers both the buy-side and the sell-side, telling each how to best use the other side. As a former buy-side analyst, to me it means fewer analyses, and better analyses. Aside from that, it is a game: buy-side: identify the better sell-side analysts and listen to them. Sell-side: identify clients that will generate commissions and market their best insights to them.
Regardless, analysts must identify the few factors that account for 80% of the performance in a given industry, and focus on those intensely. It helps to get into the industry organizations, which can help drive insight into the industry as a whole, and provide a backdrop for questions to ask when talking with executives in the industry.
Learning this will give an analyst a leg up on other analysts. Analysts should also understand the basic accounting structures of their industry so that they can identify companies that are not playing fair -- over-reporting income. I would add don't get negative too quickly. Frauds can develop a momentum of their own. Wait until the fraud gets large relative to the size of the industry before issuing a sell call -- wait for price momentum to go to zero. (Note: for investigative journalists, this does not apply. Jump on early, so that you can say that you warned everyone.)
Basic forensic accounting skills help, as do modeling skills, and basic statistical skills. I was surprised to learn a bunch of Excel shortcuts that I haven't seen elsewhere, and I have used Excel for nineteen years at a high level. The summary of accounting deviations is cogent, as well as pointing readers to Mulford and Schilit.
One idea that I heartily agree with: set up your spreadsheets to differentiate data and formulas. Cells with data series should only contain data. Formulas should have no numbers in them, unless they are trivial. This makes analysis a lot easier and cleaner in the long run.
The book also brings out the need to consider multiple scenarios, which help an analyst to flesh out his analysis. Being willing to consider what can go wrong, or right, richens an analysis. Also, the book warns against common pathologies that overcome analysts, notably -- Confirmation bias, overconfidence, Self-Attribution-bias, Optimism, Recency, Momentum, Heuristics, Familiarity, Snakebite (won't go back to one that hurt you), Falling in love, anxiety, over-reaction, loss-aversion, etc. I have experienced a few of those myself, and would have benefited from thinking these through before becoming an analyst.
Quibbles
I would warn any analyst trying to use simple or multiple regression that they are playing with fire, unless they understand the weaknesses of the data, and the limitations of the general linear model. In twelve-plus years working on Wall Street, I never saw regression used right once.
The author seems to favor DCF over multiples. Truth, neither works well, and one must live with the weaknesses of any approach. DCF embeds a lot of assumptions that are known, though some may be wrong -- multiples embed unknown assumptions.
The author does not like price-to-sales. For industrials and utilities I would say look at a chart of price versus price-to-sales. In most cases, they track, because sales don't vary that much in the short run. If you know the high and low P/S ratios for companies in an industry (P/B for financials) you have valuable information. It gives you boundaries to look at in buy and sell decisions.
I would also warn analysts against using Damodaran and those like him. I don't think his models are wrong so much as impractical. I would rather use a simple model that catches 80-90% of the action, versus one that catches 100% of the action, bet cannot practically be calculated.
Who would benefit from this book:
All equity analysts would benefit from this book. It is detailed, and yet practical. Some of our competitors will benefit from it, and if you don't read it, you will wonder why.
Product Details :
Hardcover: 402 pages
Publisher: McGraw-Hill; 1 edition (December 13, 2010)
Language: English
ISBN-10: 0071736387
ISBN-13: 978-0071736381
Product Dimensions: 6 x 0.5 x 9 inches
More Details about Best Practices for Equity Research Analysts: Essentials for Buy-Side and Sell-Side Analysts, 1st edition
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