Equity Research HANDBOOK

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Analyst Handbook

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http://equity-research.com

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













http://equity-research.com 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. Strive to be the first first to market with any new idea or piece of information--if we aren’t, our competitors will. will. All information becomes a commodity very quickly. Each analyst should be in front of the institutional sales force no fewer than two to three times per week.

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Be provocative. Playing it safe turns into a loser’s game over time. It dulls our senses and results in lackluster analysis with no impact on our clients.

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Follow and publish regularly on at least 12-15 institutional-quality stocks with market caps generally in the $300 million - $3 billion range and with an average daily volume greater than 200,000 shares. Write all research with an eye to the institutional market--it can always be encapsulated for the retail client.

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Launch coverage on at least one new stock per quarter, pruning unproductive names from the list as required.

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Maintain an above-average stock picking performance. According to a Nelson’s survey, the average Wall Street analyst is right about 55% of the time; our goal should be to be right 65%-70% of the time.

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Develop a following with our top accounts. Each focus account should be contacted at least once per month. This list will will be developed with with the sales force and will be monitored regularly.

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Cooperate with corporate finance. Every 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.













http://equity-research.com positions in your stocks as you would an institutional client—add them to your contact list. Talk to April Langel regularly about your stocks, maintain an active Focus List, and speak to the entire retail department periodically about your group and your best ideas. Return all calls calls from brokers within within 24 hours. There should be regular visits to the branches, with a goal of 5 10 visits per year. Take company management to the major branches and arrange field trips to local companies. •

Keep trading informed about anything that you think will impact a stock's price and any clients clients who have indicated indicated an interest in your stocks. Keep tabs on our positions in your stocks. If 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 Greenwich Associates regularly surveys clients about what they want from the sell-side and how they pay us. The following results should be used to guide us in developing our institutional business. •

Who controls commissions has changed radically over the last fifteen years. Where it used to be analyst votes that directed about 50% of commissions in the mid 1980s, that has fallen to less than 25%. Portfolio managers don’t fair much better, accounting for only about 30% of commission flow. The 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 50% of all commissions. This 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 increase account penetration. In 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.

•

The top requirements for analysts to have credibility with clients haven’t changed much over the years--they don’t want the sizzle, and they still want the steak. The top four requirements ranked are: ◊

Detailed industry reports













http://equity-research.com Credibility alone, however, does not get us paid--it only gets us in the door. Ideas and access are what ring the cash register, with the following being the most important: ◊ ◊ ◊ ◊ ◊

Bottoms-up research with strong financial analysis Ideas Regular follow up Electronic access to research--85% name First Call as primary electronic source Telephone access to analysts is better than visits

Commission Productivity Our productivity measured as nickel business per analyst is below our regional peers as shown in the following table Institutional Commissions Per Analyst ($ millions) First Albany 1.5 Janney 1.4 Advest 0.6 Stifel 0.6 BB&T 0.5 Ferris Baker Watts 0.5 Ryan Beck

0.4

This is not difficult to fix--more stocks, larger cap (not large-cap), more ideas, and more impact-oriented calls, and the regular commissions will take care of themselves.

Market Cap Targets We 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 volume in this area area to make it a profitable business longer term. Data as of February 2004 shows that only about 1% of institutionally invested funds measured by market cap and 4% by trading volume were in nano- and micro-cap stocks. Percent Of Total

Stocks

Mkt Cap

Volume

Inst Mkt Cap Inst Volume













http://equity-research.com Nano (Less Than 100 Mil) Total

34.4% 34.4%

0.3%

9.5%

0.1%

1.1%

100.0%

100.0%

100.0%

100.0%

100.0%

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 major markets or to do block trades in this high-end segment. Net 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. We do need, however, to follow a handful of mega- and large-cap bellwethers to establish our industry expertise and to facilitate our vote penetration at large voting accounts. Our current mix is very reasonable, but somewhat meaningless since we have so few stocks under coverage. At a 150-stock coverage level, the targeted mix would give us about 100 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.

Mega Large Mid Small Micro Nano

Ryan Beck Research Coverage Current Mix 2-year Target Mix 2% 5% 32 15 25 40 31 25 9 10 1 5

Morning Meeting This is our most crucial interaction interaction with the sales force and trading--without trading--without a high- impact morning meeting, we cannot leverage our research, and ultimately will fail as an organization.

Every 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 like a difficult goal, but let’s look at a typical example: The basics: There are 22 trading days in the average month and let’s let’s assume that a















http://equity-research.com Frequency:

At a minimum, all Focus List, Buys, and Sells should have a call two two times per month. Holds can be only once a month.

Content:

Not every call has to be action oriented, although the more action the better. The sales force (and the clients) need to be constantly updated as events unfold to reinforce our point of view, and to give early warning of a change in our point of view.

So, where does this leave us as to the number of calls? Focus List Buys Holds Sells Total calls

1x2= 2 7 x 2 = 14 4x1= 4 1x2= 2 22, or 1 per day for every day of the month .

Why two calls per month on Buy/Sell rated stocks? First of all, we aren’t doing our job if we don’t speak with every company we follow at least once a month, preferably midmonth 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.” It’s really that simple, and there’s no excuse for not taking the high road on this issue.

You 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 Buy/Sell rated stocks, let’s presume that you want the sales force to know these stories better than your Hold rated stocks and that you want them to make regular contact with the clients. The only way to













http://equity-research.com •

Take the time to analyze ideas that you get from talking with clients. They 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 just do the work for one client--flesh it out and use it to increase your impact with the sales force and all our clients.

•

Additionally, let’s not forget that our job isn’t done just because we launched coverage on a new stock. The 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 You Say It Is Oftentimes More Important Than What You Say

The 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. First of all, base your presentation on your First Call note. If you have structured it properly, you have already laid out the call for the sales force. Your comments should simply add color and make sure that the sales force understands the importance of the information. Under no circumstances should you simply read the note to the sales force. The salesmen and traders have to take what might be a two to three minute presentation from research and condense it into a 30-60 second portfolio manager or trader call. In order to help in this process, I would recommend that your presentation (and to some extent, your write up) stay close to the following general format: Always start your call as follows: 1)

The company I'm going to discuss is: Its symbol is: It closed yesterday at:













http://equity-research.com OR This is an information call that lends further support to our investment thesis which is ______________. 3)

Our price target for the stock is ______.

4)

The principal reasons for these changes are: 1) 2) 3) 4) 5) NEVER, NEVER, NEVER have more than five points in any call, and try to keep it to three.

5)

This is/is not proprietary information. It was obtained from a general meeting, private conversation, proprietary analysis, etc.

6)

As a result of these changes, I now appear to be in line with consensus... OR As a result of these changes I now appear to be at odds with the consensus of ______ because...... becau se......

7)

The stock's recent trading has been characterized by (if there is

significant














First Call has the widest distribution, appearing on well over 30,000 individual desktops worldwide. worldwide. Its data base contains almost 10 million documents, so we have to be quick, punchy, and insightful in order to battle for mind share.

•

Clients view First Call as their primary and most important source of information. A recent survey survey by Greenwich Associates found that electronic distribution was the most important means of obtaining information, with about 85% naming First Call as their preferred source for obtaining research.

•

According to a recent First Call survey, the five most important items in their data base are displayed in the following following list. Since we control the content and timeliness of four of the five items, there is no acceptable excuse for not being at the top of our game in giving customers what they want. • • • • •

Earnings estimates Analyst recommendations Revenue estimates Company pre-announcements Growth rates

•

You can get your message out even if an individual salesperson decides to not make your call. Not all of the sales force will will embrace all your ideas ideas due to different client requirements for market cap, sector focus, investment goals, and so forth. First Call is the great equalizer.

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With such a large dependency on First Call by virtually every major and regional brokerage firm, it is crucial to format research notes for maximum impact. First Call surveys tell us that the average client spends only 10-15 seconds scanning the note, so the following approach is critical.














First Call notes must be posted by 8:00 a.m. to have any impact. This 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. Obviously, breaking news during the day that requires a note can’t meet this requirement, and these notes should be posted as soon as possible.

•

Our goal is to be in the top ten brokers every quarter as to timeliness and quantity of FC notes per stock. This generally means 75% of all FC notes published before 9:30 and 4-5 FC notes per stock per quarter.

Basic Reports/Major Updates 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, possible, or it will be relegated relegated to the scrap heap. The key points from from these various are: •

A portfolio manager will spend only 20-30 seconds on the first page of a research report to decide whether or not to read it.

•

If a PM decides to read a report, he will on average read only the first three pages.

•

Research reports should generally fall into three categories: ◊ ◊ ◊

1-3 pages--distribute only on First Call 4-6 pages--always include quarterly earnings models 10+ pages--targeted at analysts and crucial for large voting accounts

Based on this input, we will put in place the following array of products:















http://equity-research.com report that covers only the highlights of the story or a long report that addresses all the issues expected in a complete company report. The approach chosen by the analyst should take into account several factors, including the complexity of the story, the ability to turn around a complete report quickly, the action in the stock, pending news, and so forth. In general, coverage should not be launched until a first draft of the complete report is in the editorial process. •

Launching coverage on a new industry or a new sector within a current industry should be done with a "franchise building" report that provides indepth industry analysis as well as our normal detailed company analysis, hopefully on two or more companies. This both establishes our credibility 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. Stocks 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 with which to to work. All updates should include at a minimum a detailed quarterly financial forecast.

•

In general, comments from the morning meeting must be documented, unless they are simply responding to news in the paper, comments from













http://equity-research.com There are many right ways to write a research report, although two questions should be answered by the analyst before it is published: •

Will I get a portfolio manager's attention with the first page?

•

Have I supplied adequate added value for an analyst?

If the answer is yes to both questions, the internal structure should be flexible and adapted to the specific situation--a stable growth company will certainly have a different focus than a company recovering from a weak period. Not all reports will will cover the same subjects--in some cases, competition may be an important factor, in others it may be new products or an analysis of recent acquisitions. In all cases, however, 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 two very different audiences--portfolio managers and analysts. A report focused on only one audience may never be read read by the other. The 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 extremely important if we ever expect him to read our reports at all. Portfolio Manager













http://equity-research.com headline can be useful in gaining attention and should be directly tied to the investment conclusion. •

The investment opinion section should address the following: ◊

It should state your recommendation and outline the most important reasons for it, such as a forecast that deviates from the consensus, a point of view that differs from most observers, a mis-valuation of the stock, etc.

◊

It should have a "what if things go wrong" section.

◊

It should summarize your valuation assumptions and present a target price.

◊

It should address the major assumptions in your revenue and earnings forecast.

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The analyst's name, email address, and telephone number should be prominently displayed on the cover so that the PM can reach the analyst without fumbling through the report to try to find the author.

•

If you have grabbed the portfolio manager's attention by this point, he may













http://equity-research.com Whatever else this section does, it must address one key issue : How does this company make money? Does it sell performance, hopes and dreams, or the better mousetrap? What have been the keys to its success--do one or two two products and/or services account for the majority of its business? What products are the key to its future? Among the other basic questions are the following: •

How well does it do in its basic business? Is it growing growing slower or faster than its industry? Is its success tied to the market in which it operates or can it stimulate new demand in other markets and/or geographies? Is it early to market with new products or is it a "me too" company?

•

What is its its competitive position? Is it gaining or losing share? Is its market in its infancy or is it mature?

•

What are the key determinants of financial performance? What are the key levers for the future--revenue growth, market share, expense control, expanding/contracting margins, financial leverage?

•

What are the company's near-term and long-term goals--product, markets, growth, financial?














Where are the company’s products manufactured? Is there any currency impact? What changes have there been in material costs, labor, fuel, overhead, etc.?

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Are R&D expenses increasing increasing or falling rapidly? Is there a substantial change in R&D planned for new products? Are abnormal expenses being incurred due to opening new plants, changes in product line, etc?

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What can be learned from the company's customers, suppliers, or competitors? Are its products being challenged by new competitors, new technologies, or new business ideas?

Management

While this is sometimes not particularly important for very large-cap stocks, it is crucial for small- and mid-cap companies. This section should address those issues that are central to your investment thesis--simply naming the management and their experience generally does not add much value. •

How is the company structured? Do the structure and compensation
















A short-term quarterly forecast (the previous, current, and next fiscal year) including year-to-date results should be made. Projections should show complete quarterly income statements with a discussion of each major component of the projection.

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A long-term annual forecast should be made. In addition to the normal income statement, it should consider the following: ◊

It should analyze the trend in sales, margins, earnings, etc., with accompanying rationale. Where possible, it should be made by line of business. If growth is accelerating or decelerating from the historical trend line--why? The discussion should consider changes in the company's major markets, its competition, new products, changes in expense structure, etc.













http://equity-research.com forecasts if they are required to support your investment thesis. This analysis may include the following: ◊

How realistic is the balance sheet? Are assets or liabilities liabilities overstated or understated? How have acquisitions influenced the the balance sheet?

◊

Does a ratio analysis--inventory turns, DSO, current ratio, capital turns, etc.--provide any additional insights into the company?

◊

What is the debt level? Is it affected by short-term swings in interest rates? What are its repayment obligations? obligations? Does it have adequate cash flow to cover them?

◊

When will it run out of cash? Is it more likely that it will raise debt or













http://equity-research.com Production Targets While each analyst will develop his or her own approach to generating business, publishing our research is the cornerstone of our business. It 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. In many respects, publishing is for the analyst, not for the reader. It makes you think and should result in new ways to look at a company or your industry industry sector. It tests your models and forecasts. It tells you you whether your valuation techniques and resulting price targets make sense. Net net, it tells you how well you you are doing your job.














Industry reports are crucial crucial in convincing clients that we really do know what we are talking. This 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. simultaneously. If your industry does not lend itself to at least a quarterly report, consider a periodic overview, focusing on one or two major issues.

•

Mindless monthlies (quarterlies) are just that--mindless. Repackaging your First Call notes or short reports with a few statistics offers no added value to anyone, nor does simply regurgitating a handful of government statistics. Make these reports into full-blown industry reports or don’t make them at all.













http://equity-research.com Setting target prices, prices, however, also needs a time horizon to make them effective. This 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. Time horizons for technology stocks should probably never be more than six months unless you are a masochist, while looking out 12-18 months is common for packaged goods. Consider the following: •

Carefully look at the predictability of your industry sector and the inherent volatility of the stocks. Keep your time horizons horizons in line with with both. Never project price targets beyond your ability to forecast.

•

Evaluate the impact of outside events on your sector and your ability to
















Ranking of All Responses P/E-To-Growth P/E

20% 19













http://equity-research.com It’s just that easy. Adding “in our opinion” or “we “we estimate that” will will take care of most offending promises. In many cases, simply using the word “should” instead of the word “will” will also fix the problem. 2)

Forecasts and estimates must be clearly indicated as such.













http://equity-research.com 6)

You must not create or pass on rumors.

You 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













http://equity-research.com Dealing With The Press The press is your friend if you use it correctly .













http://equity-research.com determine bonuses, they will be used to help focus our attention on areas where we need improvement as an organization, and more importantly, as individual analysts. We 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.







































Equity Research HANDBOOK

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