More often than not, your stock market advisor goes beyond the traditional role of execution and gives you stock trading and investing ideas in the market. Your broker must be having its own research team and there are a plethora of research reports that are issued by the research. What should be your first reaction when the advisor gives you a research report to read and act on? To begin with, it is a good habit to read the research report before taking an investment decision to invest in any stock. However, you can just take a decision based on a reading of the report and you must ask some real probing questions to your advisor. How do you go about it?
When your broker hands over a copy of a research report prepared by his high profile analyst what should your reaction be? As a discerning investor, you should ask some serious questions. Here are six such critical questions you can ask your advisor before taking an investment call based on the research report.
1. Is the report a clear buy/sell and what are the risks involved?
Every research report has a key action point and you need to understand this better. Be clear as to the intent of the analyst in this case. Is he only upgrading this particular stock or has he upgraded many more stocks with a similar profile? Check what is the logic for selecting this stock only? Find out what are the key triggers for this upgrade and look if targets are realistic. Focus on the risks that this stock could create to your portfolio. You must be very clear if this is merely an expression of opinion or a clear buy call?
2. Discuss the validity of the assumptions and the specific factors considered
Once you are clear on the theme of the report, the next step is to understand the underlying assumptions. Are the financial projections for the sector in sync with what other analysts are projecting? Check with your financial advisor on the specific tangible and intangible benefits that the analyst sees in the particular stock. Is the price target subject to certain conditions and how realistic are these conditions?
3. How far is the price target and does it offer a margin of safety?
This is a typical Buffettian concept of value investing. You need to understand the gap between the valuation that the analyst is projecting and the actual price of the stock. If the gap is just about 10-15% then there is no great idea in chasing the stock. That is the kind of gap that will be eaten away by errors and omissions. You need a clear margin of safety where the stock is quoting at least 50-60% lower than the intrinsic value of the stock. As an investor, the research report has to be actionable and substantially meaningful.
4. Check regarding the secondary level validations done for the view
This is a very important question to ask your financial advisor about the quality of the report because when it comes to stocks, you must be a sceptic. Are the analyst view in tune with reality and the market consensus and why is the analyst being different? What are the primary and secondary sources of data considered? Has the analyst done the channel checks through industry experts, dealers, wholesalers and retailers? Has the analyst considered multiple sources about the perceived risks?
5. Do you see any conflict of interest between the analyst and his calls?
This is a delicate but important question. Quite often there are conflicts of interest in any recommendations. For example, the analyst may have recommended the stock but an arm of the broker may be having an investment relationship with the company. Often, a group company may be doing consultancy work for the target company. The investment and proprietary arm of the broker may have already accumulated the stock in their books in advance. While research reports do contain disclaimers, they are more of safe harbour provisions. You need to address these questions point blank.
6. Litmus test: does this stock fit into your overall portfolio
That is the last but the most important test in this case. Any stock ultimately needs to fit into your overall financial plan. If the report recommends an IT stock and you are already overexposed, then the stock does not add much value. Also, if the risk profile of the stock does not match yours then again the stock does not add much value.
As an investor, you must probe your financial advisor with questions before investing in a stock. You need to pass all such ideas through this 6-point test before taking your call. You are entitled to ask these questions and your advisor will only be more than happy to answer.
Disclaimer: The author is Head of Research & ARQ at Angel Broking. Views expressed are his own