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Analyst Research Is Valuable for Background Understanding

Street security analysts are good for something. Their reports are useful for understanding the business fundamentals of companies and industries. Research reports detail numerous aspects of a company and provide good background for an investor, such as the earnings outlook, profit forecasts and earning models, business operations, the market, competition, issues and challenges, management, and finances.

Analysts are highly knowledgeable on the industries they cover, especially if they have tracked a particular company for a number of years. They attend briefings for company investors, participate in management conference calls with the Street, and periodically talk with company 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 expose critical elements. Because analysts have active contact with executives, they are completely familiar with the company party line, its goals and objectives, and its management style. Individual investors are rarely privy to this type of information directly, but this color can sometimes be obtained in research reports.

Analysts are good at identifying how particular events and influences could impact a company’s outlook. When news breaks or an event occurs, Street analysts can provide detached, cool-headed, informative commentary. 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 on and explain such circumstances. Although such research is often rushed and tends to be a short-term interpretation, it is still 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 forecast 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 of 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 respond precipitously 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 reacts accordingly. Earnings estimates are a good way for investors to get a handle on Street expectations and the general magnitude of earnings growth.

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