Equity Analysis: Art Or Science?

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This post was originally published here.

I’ve seen a lot of equity analysts come and go throughout my 25 years in the business. I have seen many different strategies and approaches to our practice. What I can say is that people in this industry exist along a continuum. In equity analysis, there are those who prefer the data and those who prefer the story. The logicians, the storytellers, and then people in the middle.

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Two Types of Equity Analysts

Let me explain what I mean. There are equity analysts who let the data show them the way. They read charts and trends and decide what the story is based on what the numbers are telling them. They construct the narrative from the data.

And then there is the type of equity analyst who comes up with the narrative first and then finds the data to fit the story in their minds. They pick and choose the graphs that support their imagination. Or they rely on their industry insights or familiarity with company leadership that lies outside the realm of facts and figures. (Speaking of facts and figures, check out my post on the difference between stock value and stock price here.) Oftentimes this narrative is based on nothing but intuition, dreams, and imagination.)

But hey, that’s part of what makes the stock market so interesting, right? It is the analysis, unfolding, and reward of the dreams of humanity’s organizations. We wager on the rise and fall of companies — the great empires of our generation.

Equity Analysis: Looking into the Future

Equity analysts possess a vision of the future unseen by the market, and then they attempt to convince other people to make bets on that vision. When that vision becomes a reality, people get a large payoff for their imagination.
Imagination is something that lies beyond pure data. Science follows rules, like the laws of physics, which are mostly consistent over time. But the rules of finance? Well, there is only one that matters — that there are no rules.

Analysts try their hardest to develop frameworks for interpreting and predicting the financial system. The simple fact is that in equity analysis, it is impossible to be totally certain. It defies logic because the system is composed of individual buyers behaving in irrational ways.

Not to mention that financial markets are self-correcting. Somebody comes up with a framework that works, others find out, and the market corrects. This process changes the underlying assumptions on which that framework rests. It’s impossible to establish certainty inside a constantly shifting environment.

The Toss Up: Emotions or Objectivity

So, what should we prioritize as equity analysts? Facts, or imagination? Data, or gut instinct? Well, that’s a complicated question.
Obviously, we need to have an accurate system for interpreting the raw data. We need to have the analytical skills and insight to know what is actually happening in the company. We develop scientific methods for determining the objective value of a company so that we avoid operating only on our emotions and imagination. Sometimes the result is that many analysts totally reject the subjective elements of their day-to-day work.

I have seen it many times. Some equity analysts strive so hard to eliminate emotion and establish objectivity that they fail to cultivate the human elements that are necessary to succeed in this industry.

I remember a young analyst I hired while I was Head of Research at a large broker here in Thailand. He was strong in the scientific aspects of equity analysis, but he relied almost exclusively on data when he presented his ideas. He sold his ideas mathematically, not emotionally. The result was that when fund managers sat down to compare the ideas in front them, his ideas consistently paled in comparison to other more artfully presented options.

Two Sides of the Same Coin

Objective logic is important, but it does not reign supreme. The road to the top of equity analysis requires some “softer skills” as well.

Think of an artist. One must choose the scientific tools to value companies like a painter choosing his or her brush. The analyst’s artwork is composed of facts, figures, and charts. He or she uses the science of data analysis as the basis for an artistic narrative. They must paint a compelling picture of the value, momentum, direction, and risk of a company. This picture is the artistic vehicle that equity analysts use to sell their vision in the marketplace of ideas.

You must be capable of navigating the world of persuasion and influence. At the end of the day, your job is to present interesting investment ideas in a way that compels buy-side managers to risk their client’s money on them.

Your job is to enable someone to share your vision of the future. To give them a glimpse into a world that does not yet exist. This is a difficult task, and it takes your entire career to learn to do this effectively.

The Valuation Master Class

I teach my students in the Valuation Master Class to combine the objective world of equity analysis with the subjective world of influence. You can learn the difficult analytical forecasting and valuation portion, as well as the soft persuasive skills you need to succeed.

For instance, Valuation Master Class students produce original equity analysis research reports just like you would in the professional world. They also engage in live debates with other students about whether to buy or sell a stock.

It truly is hands-on practice. As an instructor, it warms my heart to see students nail an accurate valuation and then execute a perfect argument to sell me on the idea.

That is the skill that truly matters in the real world; it drives revenue for your client, it drives revenue for your organization, and it drives success for your career.
Develop it!

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