Equity research reports: contents, ratings and price targets

What is an equity research report for?

An equity research report estimates a company’s intrinsic value, compares it with the market price and recommends what to do. It rests on qualitative and quantitative analysis of the business model, the industry and the financial results.

Its purpose is to persuade. The analyst wants readers to act on the recommendation, so the report must give convincing evidence. It is not a regulatory disclosure (that is the company’s job) and not a neutral news summary: recent events matter only as evidence for the call. And it cannot persuade before the reader understands the company, its industry, its competitors and its risks.

Two kinds of firm write these reports (the next lesson compares them). A sell-side report is written for wide distribution to a bank’s or broker’s clients. A buy-side report is written inside an asset manager to support its own decisions.

A report is written on one of two occasions.

Report	When	What it covers
Initiating coverage	the first report on a company, often soon after its initial public offering (IPO), or when a firm starts covering it	a thorough analysis of the industry, competitive position and outlook, introducing the company to readers
Periodic (ongoing) report	after an episodic event (a merger or acquisition) or an expected announcement (quarterly earnings)	what the news changes: results against expectations, transitory versus lasting causes, any change to the rating or target

Initiating coverage is the thorough introduction. A periodic report is shorter, because its readers already know the company.

Research report

• Initiating coverage Use it first report, often after an initial public offering; thorough
• Periodic report Use it after an event or an expected announcement
  • Episodic event a merger or acquisition
  • Expected announcement quarterly earnings

Take Kestrel Air, a fictional airline. After quarterly results, its analyst sees earnings per share (EPS) 12% below expectations. She traces the miss to a one-off engine-repair charge and raises the target price 4%, because bookings for the next season are strong. A miss does not have to mean a cut: the analyst separates transitory from long-term factors.

A detailed report has five sections, and the rest of the lesson walks through them in reading order.

Equity research reportwritten to persuade; summary first, written last

• Opinion and investment summary Memorize the first page
  • Price target point or range, usually one year
  • Investment thesis why the stock is mispriced
  • Catalysts events that could close the gap
  • First-page data ticker, sector, market capitalization, market float, recent news, earnings
• Business, industry and competitive position Memorize business model, peers, the forces that matter
• Financial analysis and valuation Memorize key ratios only; more than one valuation approach
• Investment risks Memorize company, industry, economy; built into the valuation
• Sustainability and other factors Know the idea depth depends on jurisdiction and industry

How does a price target become a rating?

Use it

A recommendation is a rating of buy, hold or sell, measured over a horizon that is usually one or two years. An absolute rating looks at the expected return itself. A relative rating compares it with a benchmark: an index, an industry or regional benchmark, or the other companies the analyst covers. Relative ratings are often worded overweight, neutral, underweight, a suggested portfolio weight.

The number behind either kind is the expected appreciation to the target.

$$\text{Expected appreciation} = \dfrac{\text{Target price} - \text{Current price}}{\text{Current price}}$$

As a rule of thumb, a buy needs expected appreciation of at least 10%-15% (absolute, or above the benchmark). A sell is an expected fall, or a shortfall against the benchmark, of at least 10%-15%. Hold or neutral sits in between. There is no uniform standard: each firm sets its own bands.

For a relative rating, take one extra step: subtract the benchmark’s expected return from the expected appreciation, in percentage points, and compare the difference with the firm’s band.

Questions also give the expected return and ask for the target, or the target and the return and ask for the price.

Exam tip Divide by the current price, not the target. 9.60 ÷ 57.60 = 16.7% is the classic slip.

What goes on the first page?

Memorize

The report opens with the analyst’s opinion and investment summary: the recommendation, the price target and the return the target implies. The price target is a point estimate or a range. It is usually set over one year, but it can be tied to company milestones such as trial results, regulatory approvals or a patent expiry.

Two items explain the call. The investment thesis is a short statement of why the analyst believes the stock is mispriced, covering company-specific drivers and the economic and industry backdrop. It must line up with reaching the target within the horizon, and it is a summary, not the detailed analysis. The catalysts are expected events or developments that could make the market revalue the stock toward intrinsic value, such as a product launch, a contract award or a ruling. They matter most when the thesis depends on one event.

For Kestrel Air:

• Thesis: “The market prices Kestrel Air as if its new long-haul routes will lose money; we expect them to break even within 18 months.”
• Catalysts: “First-half results in July; approval of the new airport slots in September.”

The first page also carries the ticker, the primary sector and industry, market capitalization, the market float (the shares available for trading, covered in the lesson on liquidity, float and average daily volume), recent developments, and a summary of recent and forecast financial data, especially earnings. Key charts and tables often run down the margin.

Exam tip The first page is read first but written last, so that it agrees with everything after it.

Business, industry and competitive position

In a report that initiates coverage, the business description is detailed. It covers the business model, products, services, major suppliers and customers, how the company creates value, its strategy, and the key drivers of revenue and expenses. Pricing, distribution and how stable the market share is may also feature. The best starting points are the management discussion and analysis (MD&A) in the annual report, other regulatory filings, industry publications and press releases. The analyst writes for a broad audience of investors, not for industry specialists, even when she is one. The business model itself is a Corporate Issuers topic, so this lesson only places it in the report.

Investors see a company’s competitors as the nearest substitutes for owning its shares, so the report builds a peer group . Companies often avoid naming competitors in their filings. Some filings (in the United States, proxy statements) list the peers used to set executive pay, and that list can stretch beyond direct competitors. Data providers offer peer lists built from industry classifications, and different providers return different lists. Choosing peers takes judgment, which the relative valuation module develops.

Porter’s Five Forces and the PESTLE framework (political, economic, social, technological, legal and environmental factors) shape the industry discussion. But listing all five forces and all six PESTLE factors is a superficial checklist. The analyst focuses on the few that most affect this company’s performance, as covered in Porter’s Five Forces and PESTLE.

Financial analysis and valuation

The financial analysis is not an exhaustive statement analysis. The analyst picks the measures and ratios that reflect her economic view and support the thesis and the valuation. She reads the company’s own disclosures and footnotes rather than relying only on data-provider figures, because that is where poor earnings quality or questionable revenue or expense recognition shows up (see warning signs of manipulation).

Many industries have their own ratios: proven reserves for oil producers, revenue per available room for hotels, and for airlines available seat kilometers (ASK). Available seat kilometers add up, for every flight, the seats available times the kilometers flown. Revenue per ASK (RASK) and cost per ASK (CASK) give unit economics that compare across airlines.

Know what ASK, RASK and CASK measure. The curriculum defines them but works no calculation with them.

On valuation, analysts usually use more than one approach. The absolute approach is a cash flow projection model whose level of detail follows the company’s value drivers (the discounted cash flow and forecasting modules). The relative approach uses multiples, defined and calculated the same way for the company and a carefully chosen peer group.

Investment risks

The target should reflect all the opportunities and risks over the horizon, so the report adds a discussion of what could go wrong. The sources are the risk factors in the MD&A, earnings call transcripts, investor presentations and news releases.

Investment risks

• Company-specific Use it one product or client, operations, strategy
• Industry-wide Use it cycles, new entrants, regulation
• Macroeconomic Use it inflation, interest rates, exchange rates

A change in customer behavior in one industry can spill over into another. Suppose home-workout apps spread: gym operators lose members, and makers of commercial gym equipment see orders fall. This kind of shift is a transitory risk factor when companies can adapt to it, for example an equipment maker that starts selling connected machines for the home. Those that fail to adapt suffer if the change becomes permanent. So the analyst judges each company’s adaptability against its peers and what mitigates the risk.

Then she translates the key risks into the valuation explicitly, for example a price range under different fuel-price scenarios for an airline, or approval timing and odds for a drug developer.

Exam tip Scenarios for a key risk belong in the investment risks discussion, even though they feed the valuation.

Sustainability and other factors

Many reports have a sustainability section on factors that matter to investors. Its focus varies by jurisdiction and industry. Where institutional investors commonly apply environmental, social and governance (ESG) principles, it covers the company’s strengths, weaknesses and controversies in those areas. Where sustainability factors are expected to have a material financial effect on revenue and earnings (energy producers, heavy energy users such as electric utilities, makers of energy-hungry products), it gets a separate, detailed analysis, often of the company’s energy transition plan.

Go deeper Practicing research as a student

University students can practice writing equity research in the CFA Institute Research Challenge, where small teams analyze a listed company and present a recommendation. Teams are judged on the quality of the analysis, not on whether the price call turns out right.

Can you place every item?

Sort ten items from a report into the five sections, then rate six shares against a benchmark.