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Analyst Research Is Valuable for Background Understanding

Street security analysts are good for something; they publish expert company and industry research, which is useful for gaining a thorough understanding of the business fundamentals. Research reports detail numerous aspects of a company that provide good background for an investor. Areas such as the earnings outlook, profit forecasts and earning models, business operations, the market, competition, issues and challenges, management, and finances can be readily comprehended by utilizing the reports of research analysts. Such analysts are highly knowledgeable on the industries they cover, and if they have tracked a particular company for a few years, their expertise is deep. Analysts attend briefings for company investors, participate in management conference calls with the Street, and periodically talk with certain executives, such as the chief financial officer (CFO) and director of investor relations (IR). On conference calls, available to all investors to listen in on, analysts ask probing questions, flush out the real story, and are good at exposing critical elements. Because analysts have active contact with executives, they are completely familiar with the company party line, the company’s goals and objectives, and its management style. Individual investors are rarely directly privy to this type of information, but this color finds its way into research reports.

Analysts, given their usually steep company and industry expertise, are good at identifying events and influences that could have an impact on a company’s outlook. When news breaks or an event occurs, Street analysts can provide detached, cool-headed, informative commentary as to the fundamental effect it might have on a company. This is a common occurrence. A leading competitor in an industry sector has a negative earnings or order rate shortfall. A big acquisition is announced. A blockbuster new product development comes to light. A hurricane or other natural disaster takes place. All these types of news can affect the stock prices of a number of companies. Analysts normally issue reports that shed light and provide an explanation in such circumstances. Often this research is rushed, tends to be a short-term interpretation, and can always be wrong, but it is useful for getting the gist of the situation.

Earnings estimates are another valuable tool contributed by analysts. These are normally accompanied by comprehensive earnings models that indicate forecasts of revenue, operating profit margins, tax rate, cash flow, return on equity ratios, and other such quantitative measures. Earnings projections are both quarterly and annual, and are helpful in assessing the stock price valuation based on the price-to-earnings (PE) ratio. The anticipated rate of growth in profits is an important element in the overall outlook for a company. But the best use of these numbers is in comparing actual results. Stock prices react each quarter to the slightest shortfall or overachievement in results. And they can move precipitously in response to modifications in analysts’ earnings forecasts. Sometimes a minor rise indicates materially improving prospects. A trivial reduction can signal noticeably eroding business conditions. The stock price responds accordingly. Single figure estimates tend to cluster together and usually reflect the published management guidance. Still, earnings estimates are a good means for investors to get a handle on Street expectations and the general magnitude of earnings growth.

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