Three Critical Steps for Extracting Great Insights (Step 1: Identify Parameters) by James J. Valentine, CFA, The Finance Professionals’ Post
Think of your favorite CNBC journalist and ask why he or she is likely to get more information from a CEO than a typical analyst. If you don’t have an answer, it’s because the top journalists have been trained to use best practices for interviewing (or even “interrogating”) which can make them incredibly effective.
Throughout my career as an equity research analyst, I observed some analysts were much better than others at extracting insights from information sources (e.g. proprietary industry sources, company management, etc.), but I didn’t know exactly why. Now in the role of training analysts, I’m routinely asked, “How do I get more insights from others?” In my effort to answer this question and determine why some analysts are better than others in getting insights from others, I identified the best practices in this area, which primarily come from journalism, the legal industry and law enforcement (yes, some of the most sophisticated interviewing practices are used by law enforcement).
I put all of these best practices into a fairly simple 3-dimension model, which I’ve dubbed “ICE™”:
Due to space constraints, I’ll delve into the “I” in this post and then move onto “C” and “E” in future posts. These tactics can help in almost any exchange for information, ranging from high profile one-on-one interviews to something as simple as an email exchange.
Which of these questions posed to company management is more likely to evoke an answer useful for analyzing a stock:
- “Is there anything we should discuss in your labor expense line item?”
- “Was the 3% wage inflation in the recent quarter, which compares to only a 1% increase for the prior four quarters, because the company is beginning to lap its productivity initiatives from last year?”
Here’s the simple fact: If your question (or lead-in to your question) references specific parameters (e.g. historical trends, consensus expectations, your forecast, etc.) you have a much higher likelihood of getting an insightful answer that will help in stock picking.
Hopefully this underscores that the more you know before the interview, the more you can refine the question (and thus the response) to get to the heart of the issue. The problem is you don’t have endless hours to prepare for each interview, which is why it’s a best practice to focus only on the 1-4 critical factors for a stock. Other than building rapport with the interviewee, all of your questions should help to clarify assumptions around a stock’s critical factors. (This is also the first step of our ASPIRE™ framework for generating unique insights.)
In Exhibit 1 below we provide questioning strategies that reference specific parameters, which should result in more specific answers from the interviewee. We have designed the table with the most effective strategies on the top, but since you won’t always have public goals from the interviewee or a third-party forecast, you may need to move down to other strategies (which are still more effective than questions lacking parameters).
Exhibit 1: Questioning Strategies That Reference Specific Parameters
|Questioning Strategies That Specify Parameters||Examples|
|Reference Interviewee’s Stated Goals (when available): Ensures response is reconciled with interviewee’s goals||Can you help me get comfortable with management’s long-term goal of 1% labor cost inflation, given that it was up almost 3% in the recent quarter?|
|Reference Credible Third-party Forecast (when available): Keeps interviewee within the parameters of this credible forecast||Do you believe the Global Aircraft Association’s long-term forecast for 6% intra-Asia passenger traffic is realistic?|
|Reference Past or Continuation of Trends: Frames the past which helps to keep interviewee’s response more realistic||Should I assume that the lack of labor productivity improvement in the most recent quarter will continue?|
|Offer Options or Scaling: Keeps interviewee’s response within a predefined range||Over the next 18 months, is it more realistic that labor inflation will return to the highs of 6%-7%, as seen 4-5 years ago, or potentially be flat, similar to a target set by your largest competitor?|
|Hypothesize: Challenges interviewees to respond with their own hypothesis||I forecast the major productivity improvements of the prior year will slow to less than 1%, given the weak numbers in the most recent quarter.|
|Make Implications: Uses your insights to build a well-constructed implication that will likely elicit a quantifiable response||Your largest competitor has stated one of its competitors has been dropping pricing and we see in your most recent quarter, your average selling price was down. Can I assume you are the company they are referencing?|
|Triangulate: Uses information from other related areas to narrow possible outcomes||I’ve heard management state it generates $60 per unit from product sold in China. If your company sells 50,000 units per day in Shanghai and we’ve been told Shanghai is over 50% of your China revenue, the math suggests you generate $1.4 billion per year in China. Are there any elements of my assumptions that appear way off?|
Best Practices for Equity Research Analysts – Book Review
A real-world guide to becoming a top-performing equity analyst
Praise for Best Practices for Equity Research Analysts:
“Jim Valentine has taken his decades of experience as a highly successful security analyst and written an effective and comprehensive guide to doing the job right. I only wish I had this book by my side throughout my career.” — Byron R. Wien, Vice Chairman, Blackstone Advisory Partners LP
“Given the fast pace and high-pressure nature of the markets, analysts don’t have the luxury to make mistakes. James J. Valentine’s Best Practices for Equity Research Analysts should be required reading for all new and experienced analysts, particularly those who were not lucky enough to be brought up in the business under a mentor. Valentine can be that mentor.” — Jami Rubin, Managing Director, Global Investment Research, Goldman Sachs
“Jim’s book is an excellent window into the world of securities research. Very few works cover the complete life cycle of an analyst and the necessary balance between theory and practice. This is one of them.” — Juan-Luis Perez, Global Director of Research, Morgan Stanley
“Valentine’s book doesn’t rehash the basics of finance but covers all the nonacademic topics in terms of how the analysts should manage their time, resources, data, and contacts in order to come up with the best stock picks. This book is required reading for beginning analysts and a must-read for all analysts who want to develop an edge.” — Carl Schweser, Founder of Schweser’s Study Program for the CFA Exam
“Best Practices for Equity Research Analysts is by far the best written and most comprehensive book that I have read on how to become a top-notch analyst. I shouldn’t be surprised; it was written by one of the best analysts that Wall Street has ever seen. Every securities firm should require their analysts to read this book.” — Eli Salzmann, Portfolio Manager
Most equity research analysts learn their trade on the job by apprenticing under a senior analyst. However, equity