The process of putting an analysis down in writing can be instrumental in making sure as many stones as possible have been turned over when researching a company. Famed investor Peter Lynch, who's credited with coining that phrase, has also been quoted as saying that “the person that turns over the most rocks wins the game. And that's always been my philosophy.” Below is an overview of the major sections to consider when writing a financial analysis report on a company.
A report should start with a description of the company in order to help investors understand the business, its industry, its motivation and any edge it might have over its competitors. These factors can prove invaluable in helping to explain why a company might be a profitable investment or not. A firm’s annual report, 10-K filing or quarterly 10-Q with the Securities and Exchange Commission (SEC) provide ideal starting points; it is surprising how rare it is for industry experts to refer to original company filings for important details. More valuable detail can be obtained from industry trade journals, reports from key rivals and other analyst reports.
To also capture key fundamentals to describe a company, look to Michael Porter. The Porter’s Five Forces model helps explain a company’s place within its industry. Specifically, the factors include the threat for new entrants to enter the market, the threat for substitute products or services, the extent to which suppliers are able to influence the company and the intensity of rivalry among existing competitors.
The motivation for a bullish or bearish stance on a company goes into this section. It can come at the top of a report and include parts of a company overview, but regardless of its position, it should cover the key investment positives and negatives.
A fundamental analysis, which can also be broken out into its own section, contains research on the firm’s financial statements, such as sales and profit growth trends, cash flow generation strength, debt levels and overall liquidity, and how this compares to the competition. No detail is too small in this section; it can also cover efficiency ratios like the primary components in the cash conversion cycle, turnover ratios and a detailed breakdown of return on equity components, such as the DuPont identity, which will break ROE into three to five different metrics.
The most important component of analyzing past trends is to synthesize them into a forecast of the company’s performance. No analyst has a crystal ball, but the best ones are able to accurately extrapolate past trends into the future, or decide which factors are the most important in defining success for a company going forward.
The most important part of any financial analysis is to come to an independent value for the stock and compare this to the market price. There are three primary valuation techniques:
- The first, and arguably most fundamental, technique is to estimate a company’s future cash flows and discount them back to the future at an estimated discount rate. This is generally referred to as a discounted cash flow analysis.
- The second is called relative value, where the fundamentalmetrics and valuation ratios (price-to-sales, price-to-earnings, P/E to growth, etc.) are compared to competitors. Another comparison analysis is to look at what other rivals have been bought out for or the price paid for an acquisition.
- The third and last technique is to look at book value and try to estimate what a company might be worth if broken up or liquidated. A book value analysis is especially insightful for financial sector stocks, for instance.
This section can be part of the bull/bear story in the investment thesis, but is meant to detail key factors that may derail either a bullish or bearish stance. The loss of patent protection for a blockbuster drug for a pharmaceutical company is a great example of a factor that can weigh heavily on the valuation for its underlying stock. Other considerations include the sector in which the firm operates. For example, the technology industry is marked by short product life cycles, which can make it hard for a firm to keep its edge following a successful product release.
The above sections could prove sufficient, but depending on the stones uncovered during a financial analysis, other new sections might be warranted. Sections covering corporate governance, the political environment or nearer-term news flow, might be worthy of a fuller analysis. Basically, anything important that can impact the future value of a stock should exist somewhere within the report.
The Bottom Line
Performance of the underlying company is most certainly to drive the performance of its stock or bonds in the future. Other derivativesecurities, such as futures and options, will also depend on an underlying investment, be it a commodity or a company. Figuring out the key drivers to the performance of a stock and putting it down in writing can be an invaluable endeavor for any investor, regardless of if a formal research report is needed.
While the big Wall Street firms pump out thousands of pages of stock analysis, you may have a different view on one or more stocks and want to get your ideas out into the marketplace. A well-crafted and organized stock analysis report can help other investors learn about stocks you have discovered. Once completed, the Internet offers many investment publishing opportunities. Putting your research out on the Internet will allow other investors to learn and profit from your analysis.
Colleagues work together to analyze data
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Report Organization Leads the Content
Structure your analysis reports to get the attention of investors and put your major findings out front, early in the report. One possible outline starts with an informational headline followed by an overview of the investment potential of the stock. The next section will be a table with important data about the stock and three to five key points about the company and its investment potential. The remainder and bulk of the report covers your in-depth analysis of the stock. As you do your research, this format will force you to dig for key points or concepts about the company.
Fundamental Analysis On Several Levels
A significant portion of your stock report will be your analysis of the company and the industry in which it operates. A top-down approach starts with the industry and covers the growth and profit potential. Then the individual company is analyzed in relation to the overall sector. A bottom-up approach focuses on the individual company with less emphasis on the business sector. With both types, cover how your stock is similar and different from the its market peers. The fundamental analysis will be heavy on the data, such as sales revenues, profit margins, historic and projected growth rates.
Putting a Valuation on the Stock
The whole point of your stock analysis report is to provide a future value estimate of the share price based on your research and the data you discussed in the analysis of the company. Just throwing a share price number out will not be sufficient. The report should include the reasoning or process you went through to produce your target price for the stock. Along with a target price, cover the risk factors that could prevent the stock from hitting the expected value.
Appeal to Investors
Set your stock report apart from the pack by slanting the approach to specific types of investors. Some of the major investment themes include growth stocks, turnaround plays, dividend growth and high-yield stocks. If you know the stock fits best into one of these categories, write your title and the report with the specific type of investor in mind. Of course, you can cross up categories if you have a story to tell that will appeal to other types of investors. For example, you may want to show how a blue chip dividend growth stock is poised to become more of a share price growth story.