The motivation for a bullish or bearish stance on a company goes into this section. It can come at the top of a report & include parts of a company overview, but regardless of its position, it should cover the key investment positives & 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 & profit growth trends, cash flow generation strength, debt levels & overall liquidity, as well as, 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 & 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 & compare this to the market price. There are three primary valuation techniques:
- The first, arguably most fundamental, technique is to estimate a company’s future cash flows & discount them back to the future at an estimated discount rate. This is generally referred to as a Discounted Cash Flow (DCF) analysis.
- The second is called Relative Value, where the fundamental metrics & 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 & 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
The performance of the underlying company is most certainly to drive the performance of its stock or bonds in the future. Other derivative securities, such as futures & 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.
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