How Does Equity Research Make Money

What is Equity Research?

Equity Research primarily means analyzing the company's financials, perform ratio analysis, forecast the financial in excel (financial modeling), and explore scenarios with the objective of making a BUY/SELL stock investment recommendation. Equity Research analyst discusses their research and analysis in their equity research reports An equity research report is a document prepared by equity research analysts or financial brokers that focuses on a specific stock, industry, currency, commodity, or fixed-income instrument, as well as a geographic region or country. It includes recommendations on why to buy or sell that stock, as well as DCF modeling, relative valuations, and so on. read more .

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In this in-depth article on Equity Research, we discuss the nuts and bolts of Equity Research.

Role of Equity Research
Hierarchy in Equity Research firms
Role of Head of Research
Job of the Senior Analyst
Responsibilities of an Associate
Responsibilities of a Junior Analyst
Typical Day at an Equity Research Firm
Who pays for Equity Research?
Equity Research Professional Approach
Equity Research Skills-Set
Top Equity Research Firms
Equity Research Compensation
Equity Research Exit Opportunities

Equity Research explanation is quite simple. Let us look at these steps below

Equity research is all about finding the valuation of a listed company (Listed companies trade on a stock exchange Stock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ. read more like NYSE or NASDAQ etc
Once you have the company under consideration, you look at the economic aspects like GDP, growth rates, the market size of the industry and the competition aspects, etc.
Once you understand the economics behind the business, perform the financial statement analysis of the historical balance sheet, cash flows, and income statement to form an opinion on how the company did in the past.
Based on management's expectation, historical performances, and industry competition, project the financial statements Financial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. read more like the BS, IS, and CFs of the company. (also called as Financial Modeling in Equity Research)
Use the Equity valuation models like DCF Discounted cash flow analysis is a method of analyzing the present value of a company, investment, or cash flow by adjusting future cash flows to the time value of money. This analysis assesses the present fair value of assets, projects, or companies by taking into account many factors such as inflation, risk, and cost of capital, as well as analyzing the company's future performance. read more , Relative valuations, a sum of parts valuation Sum of the Parts Valuation is a valuation method wherein each of the subsidiary or segment of a Company is separately valued & then all of them are added together to estimate the business's total value. read more the company.
Calculate the Fair price based on the above models and compare the fair price with the Current Market Price (stock exchange)
If the Fair Price < Current Market Price, then the company stocks are overvalued Overvalued Stocks refer to stocks having more current market value than their real earning potential or the P/E Ratio. Overvaluation of stocks might occur due to illogical decision making or deterioration in a Company's financial health. read more and should be recommended as a SELL.
If the Fair Price > Current Market Price, then the company shares are undervalued and should be recommended as aBUY.

Role of Equity Research

Equity Research plays a very critical role that fills the information gap between the buyers and sellers of shares.
The reason is that at all levels (individual or institutional) may not have the resources or the capabilities to analyze every stock.
Additionally, full information is not provided by the management due to which further in-efficiencies are created and stocks trade below or above the fair value.
Equity Research analyst An equity research analyst is a qualified professional who interprets financial information and trends of an organization or industry to provide recommendations, opinions, reports, and projections on the corporate stocks to facilitate equity trading. read more spends a lot of time, energy, and expertise to analyze stocks, follow the news, talking to the management, and provide an estimate of stock valuations.
Also, equity research tries toidentify the value stocks Value Stock is one that has the potential of selling at a higher price but due to the company's adverse condition in the market, the stock is trading at a lower price than its actual worth based on its earnings, dividend, or sales. read more out of the massive ocean of stocks and help the buyers to generate profits.

What is the Typical hierarchy in Equity Research firms?

A typical hierarchy at an Equity Research firm starts with the Head of Equities/Head of Equities at the top.
Thereafter there are Analysts (senior) covering different sectors. Each analyst mostly covers around 10-15 companies in a specific sector.
Each Senior analyst may be supported by an Associate, who in turn, may be supported by a couple of Junior Analysts.

What is the role of the Head of Research?

Head of Research acts as a key member to manage the Equity research analyst team, providing the team with leadership, coaching, and guidance to ensure that the brokerage goals and objectives are met.
They oversee research reports, publications; it's editing as well as monitor the process of analysis and brokerage recommendations.
They ensure that adequate support is provided to sales and trading teams.
Contribute to Equities by providing expert-level inputs for overall strategy, goals, initiatives, and budgets
Responsible for Analyst hiring, compensation, development, and performance management
Liaison with fund managers and the research teams

What is the job of the Senior Analyst?

Below is an excerpt from a job requirement of a Senior analyst –

source – FederatedInvestor

Typically an equity research senior analyst would cover a sector with not more than 8-15 stocks. Coverage implies tracking these stocks actively. Senior Analyst tries to bring maximum companies under coverage in the sector he/she tracks (initiating the coverage)
Many senior equity analysts cover companies that investors may want to invest in. These companies are like the high market capitalization companies or the ones with higher trading volume, and there could also be cases where investors want to invest in small-cap or mid-cap stock companies with fewer analysts coverage.
One of the most important responsibilities of Senior Analyst is to come up withQuarterly Results Update – results summary, expectation, and performance against those expectations, updating forecasts, etc.
Talking to the clients (buy side The term "buy-side" refers to entities that advise their clients like individual investors and institutional buyers on investments and securities purchases. Private equity firms, mutual fund companies, life insurance companies, unit trusts, hedge fund companies, and pension fund entities are examples of buy-side firms. read more ) and showcasing their calls on the stocks. They have to diligently communicate buy sell recommendations of stocks. Additionally, they have to articulate clearly why a certain stock should be included in their portfolio.
Write important industry event updates like conferences or management meeting updates.
To update the Sales team, dealing with and trading team about the latest news in the sector and the company, and keep them updated with the brokerage's view on the same.
Attending conference calls for important company updates, results, etc
Attend trade shows, meet company management, suppliers meetings, etc

Responsibilities of an Associate

Below is the summary of the Associate job description from efinancialcareers

The primary job of an associate is to support the Senior Analyst in the best way possible.
An associate has prior experience of around 3 years or so in a similar industry.
Updating the financial model, verifying the data, and preparing the valuation models
Working on various client requests like a request of data, industry analysis, etc
Prepare draft Equity Research Reports (update of results, events, etc.)
Work on client requests
Participate in meetings and calls with clients on the stock under coverage.

Responsibilities of a Junior Analyst

Here is a snapshot of Junior Equity Analyst's responsibilities.

source – careers.societegenerale.com

The main responsibilities of Junior Analyst are to support the Associate in every format.
The majority of the work done by Junior Analyst is related to data and excel etc.
Also, Junior Analyst may be involved in doing primary research, industry research, coordinating with clients, etc.
Maintaining the industry database, charts, graphs, and financial models, etc.

Typical Day at an Equity Research Firm

Previously, I had worked with companies like JPMorgan and CLSA India as an Equity Research Analyst. I covered Indian Oil & Gas sectors with stocks like ONGC, BPCL, HPCL, GAIL, etc. Below was my typical day as an Equity Research Analyst.

7:00 am – Reach office

Check emails from traders and salespeople
Check the stock markets (Asian Markets that open first)
Check for all the news related to your sector

7:30 am – 8:00 am Attend Morning Meeting

Morning meeting is nothing a formal discussion of the recommendations before the market opens along with Sales & Trading Team
In this morning meeting, all analysts present their views on key developments in their sector along with the Head of Research or Equities presenting their views on the general markets.

9:00 am – Market Opens

Follow the Market, look for key developments in your sector
Try to rationalize if there are any rapid stock price movements

10:00 am – Regular Work

Perform regular research analyst duties like Client Requests, Financial Model updates,
Follow the News and keep a close check

11:00 am – Regular Work / Client Discussions

Discussion with buy side clients for any explanation of research/calls
Continue doing your regular maintenance work

3:30 pm – Market Closes

Capture the market movements of the company under coverage for the day closure.
Check if there is anything that the clients should know and work accordingly.

4:00 pm – Work on New Research Publications

Work on the new research piece for publication (next day or in coming days)
Generally, research analyst targets at least 1 to 2 research pieces every week.

7:30-8:00 – go Home

If there is no earning season The Earnings season refers to the quarterly report of companies' results, such as revenue/profits, released in the first two weeks after each quarter ends (Dec, Mar, Jun, Sep). It helps investors in making investment decisions and determining the value of their investments. read more (company results), then the typical go home time is 7:30-8:00 pm. However, during earning seasons, there is no surety when you will reach home.
You need to fully prepare the result update report and keep it ready for the next day early morning publication.

Who Pays for Equity Research?

For Independent Equity Research firms: Independent equity research firms The list of top 10 equity research firms in the world comprise: JP Morgan Chases and Co, Bank of America Merrill Lynch, Credit Suisse, Barclays Capital, Citigroup, Goldman Sachs, Morgan Stanley, AllianceBernstein L.P.,UBS, and Nomura Holding Inc. read more do not have a trading and sales division One of the main functions of an investment bank in the country is sales and trading, in which the investment banking sales team pitches clients for trading ideas and the traders team executes activities related to the purchase and sale of securities and other financial instruments in the market for itself or on behalf of its clients. read more . They perform financial analysis with an idea of charging Fees on a per report basis. Also, see Equity Research vs. Sales and Trading Equity research involves conducting a thorough stock analysis, which includes financial modeling and valuation, as well as a review of financial statements, which is crucial in determining if a particular stock is a suitable investment or not. Sales and trading analysts are in responsible for marketing securities to their clients and delivering timely and relevant information that allows them to make informed decisions. read more .
For Major Equity Research firms: Fee income is earned by brokerage trades (Soft Dollars). To understand this in detail, let us look at the diagram below –

As noted above, on one side is the Buy Side firms like Hedge Funds A hedge fund is an aggressively invested portfolio made through pooling of various investors and institutional investor's fund. It supports various assets providing high returns in exchange for higher risk through multiple risk management and hedging techniques. read more , Pension Funds, Insurance Companies, Mutual funds A mutual fund is an investment fund that investors professionally manage by pooling money from multiple investors to initiate investment in securities individually held to provide greater diversification, long term gains and lower level of risks. read more , etc.
On the other side are the sell side firms like JPMorgan, Goldman Sacks, Credit Suisse, etc.
The buy side firms manage the portfolio, and they are required to invest their portfolio as per the investment objective.
Investment objective may mandate these companies to keep a portion of their assets in Stocks etc.
In such cases, the buy side analysts seek to advise from the sell side analyst for investment decisions.
The advice or the idea provided by the sell side analyst is literally for FREE.
Once the buy side analyst has taken the decision of investing in the stock, the buy side analyst may look forward to executing the trade through the Trading division of the sell side firm.
The trading division will, in turn, charge a commission for executing the trade at the lowest price.
The commission, in return, is basically the earnings of the research firms.

Equity Research Professional Approach

So what is your work like as an Equity Research Professional? Equity Research analysts follow stocks and make recommendations on whether to buy, sell, or hold those securities using Fundamental Analysis. Equity Research is a very challenging job, where an analyst may be required to spend more than 12-14 hours a day.

For creating a professional Equity Research Financial model, an expert analyst recommended approach is as follows –

Economic Analysis / Industry Analysis / Company Analysis

The very first thing you need to take care of while doing a professional analysis is to learn about the economic parameters affecting the industry, the industry dynamics, competitors, etc.
For example, when you are analyzing Alibaba Alibaba is the most profitable Chinese e-commerce company and its IPO is a big deal due to its size. With its huge size and network, Alibaba IPO may look at international expansion beyond China and may lead to price wars and intensive competition in the US. read more , you should know about each and every subdivision of Alibaba and its competitors.

Fundamental Analysis

You should be awesome at Fundamental Analysis. Fundamental Analysis means performing a Ratio Analysis of the company under consideration.
Before you start ratio analysis, you should populate at least the last 5 years of financial statements (Income Statement, Balance Sheet, and Cash Flows Cash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business's strength, profitability, & scope for betterment. read more ) in excel.
You should prepare a blank excel sheet with Separate Income Statement The income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements. read more , Balance Sheet, and Cash Flows and use neat formats.
Populate the historical financial statements (IS, BS, CF) and do the necessary adjustment for Non-recurring items Non-recurring items are income statement entries that are unusual and unexpected during regular business operations; examples include profits or losses from sale of asset, impairment costs, restructuring costs, and losses in lawsuits, and inventory write-off. read more (one time expenses or gains).
Do the Ratio Analysis Ratio analysis is the quantitative interpretation of the company's financial performance. It provides valuable information about the organization's profitability, solvency, operational efficiency and liquidity positions as represented by the financial statements. read more for Historical years
An example is presented below in Colgate Ratio Analysis

Colgate Ratio Analysis - Operating Profitability

Preparing a Professional Financial Model

Company management does not provide the future financial projections Financial projection is a statistical forecast of a company's future revenue and expenditure based on historical market patterns, internal factors, data interpretation, anticipated market developments, and experiences. To meet production or sales targets, both short-term and long-term financial estimates are sometimes evaluated. read more of the company. Therefore, it is important as a research analyst to project this data. Forecasting the financials of the company is known as Financial Modeling. I earlier wrote a 6000 words step-by-step tutorial on Financial Modeling. If you want to master Financial Modeling, you can refer to this Financial Modeling Tutorial

Valuations – DCF

Valuation is primarily done using two methods – a) Discounted Cash flow Discounted cash flow analysis is a method of analyzing the present value of a company, investment, or cash flow by adjusting future cash flows to the time value of money. This analysis assesses the present fair value of assets, projects, or companies by taking into account many factors such as inflation, risk, and cost of capital, as well as analyzing the company's future performance. read more and b)Relative Valuations.
Once your financial model is ready, you can perform Discounted cash flows as given in the steps below –

Calculate FCFF FCFF (Free cash flow to firm), or unleveled cash flow, is the cash remaining after depreciation, taxes, and other investment costs are paid from the revenue. It represents the amount of cash flow available to all the funding holders – debt holders, stockholders, preferred stockholders or bondholders. read more as discussed in class and the handbook
Apply a suitable WACC post the calculation of the capital structure
Find the Enterprise Value of the Firm (including the Terminal Value Terminal Value is the value of a project at a stage beyond which it's present value cannot be calculated. This value is the permanent value from there onwards. read more )
Find Equity Value Equity Value, also known as market capitalization, is the sum-total of the values the shareholders have made available for the business and can be calculated by multiplying the market value per share by the total number of shares outstanding. read more of the Firm after the deduction of Net Debt.
Divide Equity Value of the Firm by the total number of shares to arrive at the "Intrinsic Fair Value" of the company.
Recommend whether to "BUY" or "SELL"

Valuation – Relative Valuations

Relative valuation is based on comparing the valuation of the company under consideration with the valuation of other firms. There are valuation multiples used to value companies like PE Multiple The price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. read more , EV/EBITDA EV to EBITDA is the ratio between enterprise value and earnings before interest, taxes, depreciation, and amortization that helps the investor in the valuation of the company at a very subtle level by allowing the investor to compare a specific company to the peer company in the industry as a whole, or other comparative industries. read more , PBV ratio Price to Book Value Ratio or P/B Ratio helps to identify stock opportunities in Financial companies, especially banks, and is used with other valuation tools like PE Ratio, PCF, EV/EBITDA. Price to Book Value Ratio = Price Per Share / Book Value Per Share read more , etc.

The common approach is given below.

Identify the comparable based on the business, Market Capitalization Market capitalization or market cap is the total market value of all the outstanding shares and is calculated by multiplying the outstanding shares with the current market price. Investors use this ratio to determine the company's size rather than using total sales or total assets. read more , and other filters.
Identify a suitable trading valuation multiple to be used for this business.
Use the average valuation multiple to find the valuation of the company.
Suggest "Undervalued" or "Over-valued."

Research Report

Once you have prepared the financial modeling and find the fair valuation of the company, you need to communicate this to your clients through Research Reports. This research report is very professional in nature and is prepared with a lot of caution.
Below is a sample of the Equity Research Report. You may learn about Equity Research Report Writing here.https://www.wallstreetmojo.com/wp-content/uploads/2015/03/Reliance-Petroleum.pdf

Equity Research Skills-Set

Here are excerpts from the Equity Research Job Requirements Description –

Key highlights to note from this excerpt is –

MBA is a plus (not a necessity). If you are an MBA, then you have certain advantages, but if you are a graduate, you should not get disheartened. You have a chance if you prove your interest in finance. Please do have a look at Can an engineer get into an Investment Bank.
Financial discipline is not essential, but you must have a strong interest in the financial markets The term "financial market" refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces. read more with excellent quantitative and analytical skills.

You should be fluent in English and have excellent verbal and written communication skills.
You possess intellectual curiosity, focus, and creativity, and have a keen research instinct with creative problem-solving abilities.
Strong proficiency in Microsoft Excel and Powerpoint
CFA designation – This is one important designation that the finance industry respects. Try to ensure that you take the CFA examination The Chartered Financial Analyst (CFA®) Program offers a graduate-level curriculum and examination program designed to expand your working knowledge and practical skills related to investment decision-making. read more and pass at least a couple of levels.
I wrote a detailed post on the skills required to enter into Equity Research. My top 5 skillsets required to enter the Equity Research Industry are –

Excel Skills
Financial Modeling
Valuations
Accounting
Report Writing

You can get an in-depth understanding of the skillsets here – Equity Research Skills.

Top Equity Research Firms

Institutional Investors ranking suggests that in 2014, the best research firm was Merril Lynch Bank of America, second place was taken by JPMorgan, and Morgan Stanley came third.

Apart from the top 3 above, there are other notable equity research firms (listed below)

Deutsche Bank	Standard Chartered Bank
Credit Suisse	Cornerstone Macro
UBS	Wolfe Research
Barclays	BNP Paribas Securities
Citi	CIMB Securities
Nomura	Cowen and Co.
Goldman, Sachs & Co.	Berenberg Bank
CLSA Asia-Pacific Markets	Citic Securities
Wells Fargo Securities	CRT Capital Group
VTB Capital	Empirical Research Partners
Sberbank CIB	J. Safra Corretora
Santander	Keefe, Bruyette & Woods
ISI Group	Kempen & Co.
Daiwa Capital Markets	Otkritie Capital
Jefferies & Co.	Raymond James & Associates
Mizuho Securities Group	Renaissance Macro Research
SMBC Nikko Securities	SEB Enskilda
Macquarie Securities	ABG Sundal Collier
HSBC	Amherst Securities Group
Banco Português de Investimento	Antique Stock Broking
Batlivala & Karani Securities India	Autonomous Research
BBVA	Helvea
BGC Partners	Ichiyoshi Research Institute
BMO Capital Markets Corp.	ICICI Securities
BOCI Research	ING Financial Markets
Brasil Plural	Intermonte
Commerzbank Corporates & Markets	JB Capital Markets
Davy	Kepler Capital Markets
EFG-Hermes	LarrainVial Corredora de Bolsa
Equita S.I.M.	Lazard Capital Markets
Fidentiis Equities	MainFirst Bank
Gazprombank	N+1 Equities
Goodbody Stockbrokers	Oddo Securities
Guggenheim Securities	Okasan Securities Co.
Handelsbanken Capital Markets	Oppenheimer & Co.
Samsung Securities	Petercam
Stifel	Rabobank
Strategas Research Partners	Redburn Partners
UniCredit	Washington Analysis
Vontobel	Zelman & Associates

Equity Research Compensation

Junior Analyst/Assistants have a base comp of $45,000 – $50,000 per year (average)
Associates have a base salary of $65,000 – $90,000 per year (average) depending on the experience. Additionally, they get a bonus of 50-100% of the base salary (in an average to good year)
Senior Analysts generally have a base compensation of $125,000 – $250,000. Their bonus may range from 2-5 times the base compensation.

Equity Research Exit Opportunities

Sell Side research analyst has various Career Opportunities –

Within Equity Research Firm

If you joined as an associate, then you can move up the ladder to become a Senior analyst assuming full responsibility for the sector coverage.
Later you can move further up to become Head of Research and Head of Equities.

Private Equity Analyst

Sell side analysts also move to the Private Equity domain working as Private Equity Analyst A private equity analyst is an analyst who looks for undervalued companies for a private equity investor to buy, take them private and earn profits. The companies are primarily unlisted, and the risk is higher. read more .
Instead of analyzing public companies, they analyst private companies from the point of view of investments.
They can move up the hierarchy to become a Private Equity Fund manager. Check out the list of Top Private Equity Firms Private equity firms are investment managers who invest in many corporations' private equities using various strategies such as leveraged buyouts, growth capital, and venture capital. The top private equity firms include Apollo Global Management LLC, Blackstone Group LP, Carlyle Group, and KKR & Company LP. read more .

Investment Banking Analysts

Movement of sell side analysts to Investment banking Investment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc. read more is slightly tough but not impossible.
Sell side analysts are fully aware of financial research and modeling related work.
What they haven't worked on is the transaction-related work like IPO filing documents, Pitch books Pitch Book is an information layout or presentation used by investment banks, business brokers, corporate firms, and others to provide potential investors with the firm's main attributes and valuation analysis, which helps them decide whether or not to invest in the client's business. A pitch book is also known as Confidential Information Memorandum, which is used by the firm's sales department to help them sell products and services to a client. read more , registration work, etc. If you are confused between Investment Banking and Equity Research, read this article – Investment Banking vs. Equity Research Equity research is a mechanism through which an organization's financial well-being, i.e. assets and liabilities are analyzed, which further helps investors make investing decisions. In contrast, investment banking is a banking function that offers financial services to individuals and companies and enables them to raise capital. read more .

Buy Side Firms

Sell side analysts sometimes are also absorbed as buy side analysts (working for Mutual funds, etc.).
The buy side analysts assume the responsibility of fund managers over a period of time.

Corporate Finance

Sell side analysts work a lot on financial analysis, analyzing company projects, and its effect on the overall company's financials. Hence, they get into typical Corporate finance roles of large corporates (take care of financial analysis, planning Projects, etc.)
Another unique role they get into is Investor relations. As a sell side analyst, they get equipped with the FAQs and how to deal with critical information and its sharing, etc. Due to this, they also become eligible for Investor Relations jobs.

Conclusion

Equity Research essentially means preparing an estimate of company fair valuation for recommending the buy side clients. Though, as a research analyst, you may spend 12-16 hours a day at the office; however, this is a dream job for many who love Finance and Financial Analysis. If you like to work in a challenging and dynamic environment, then this is one career you must consider. Not only equity research job rewards analysts with relatively higher compensation, but also, it provides excellent exit opportunities.

Equity Research Video

What next?

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