Why sit in the room at all
The internet puts almost every filing, transcript and data series within reach. The syllabus is clear that this still does not substitute for direct contact with a company. Talking to the people who run the business gives an analyst a feel for the vision and the strategy for reaching it that no document conveys.
It also gives management a chance to sell. The workbook's phrase is painting rosy pictures: exaggerating the positives so that analysts write favourable stories and the share price responds. That risk is the reason for the single most important habit in this lesson.
Everything management says is an input to be cross-verified before it appears in a recommendation. Filings, past annual reports, suppliers, distributors, customers and competitors are the checks. An analyst who publishes a management claim unchecked has outsourced the job to the person with the strongest incentive to overstate.
Two ordinary skills underpin every meeting: the ability to articulate a thought clearly, and the ability to listen. On top of those, the syllabus adds four principles.
The four principles for dealing with companies
- 1Pre-meeting research. Management is generally willing to meet analysts, but the opportunity does not come often, so it has to be used fully. Before the meeting, learn the products, the industry and the competitors, be fluent in the financials, and read previous years' annual reports to see the direction the company set for itself and whether it reached the goals it announced.
- 2Independence and neutrality. Hold an unbiased opinion and keep it. Base analysis on facts, not personal inclination. And say to management, in so many words, that they should not reveal anything that is not already in the public domain.
- 3Network. Use professionals and experts who can shed light on the company's performance and plans. The person who runs the activities that matter and knows the heartbeat of the business is the most relevant contact, and that person is often not in top management. Competitors, suppliers, distributors, retailers and customers all give meaningful inputs.
- 4Clarity of questions. Time with management is only well spent if the analyst arrives with a clear and specific set of questions about the points that need resolving. Going in with a written questionnaire is the recommended practice.
An analyst reading three years of annual reports notices that a new plant announced two years ago has not shown up in fixed assets. That is pre-meeting research doing its job: the meeting now has a precise question. If the managing director answers that the plant is nearly done, the answer goes on the list to verify with suppliers, a site visit or the next filing. It does not go into the report as a fact.
When a scenario has management offering next quarter's figures, an internal production report, or any information not in the public domain, the correct action is to make clear it should not be shared and to decline. Accepting it, even without using it, puts the analyst on the wrong side of the insider trading rules covered in chapter 14. There is no option in which taking the information is right.
The five rules for communicating with clients
Once the research is done and the report written, the findings go to clients. The syllabus lays down guidelines for that communication.
- Suggestions must be realistic and rest on facts and figures. No optimistic, pessimistic or otherwise biased slant on the subject company.
- Written research reports should be simple, clear and concise.
- Any conflict of interest, such as the analyst holding shares of the subject company, is disclosed beforehand.
- Assumptions are stated clearly in the report.
- Abbreviations and jargon are either avoided or explained in plain words.
A tempting wrong option says conflicts are disclosed "if a client asks" or "after the recommendation is acted on". The rule is disclosure before the client relies on the report. Another wrong option suggests selling the shares quietly instead of disclosing. Disclosure is the requirement; the holding itself is not the offence.
The standard behind all of it
The analyst collects information from reliable sources, interprets it and converts it into recommendations that clients can use. The syllabus expects that to happen with sincerity, honesty and ethics, without bias, following SEBI's rules both in letter and in spirit. It also recommends technology such as recording devices when interviewing management or talking to clients, with one condition attached: consent is taken first.
- Meeting management cannot be replaced by the internet, but management may paint a rosy picture to move the price, so every claim is cross-verified before a recommendation.
- Four principles for company interaction: pre-meeting research, independence and neutrality (including telling management not to share non-public information), a network beyond top management, and clear specific questions, ideally a written questionnaire.
- Five rules for client communication: realistic fact-based suggestions, simple clear concise writing, conflicts of interest disclosed beforehand, assumptions stated, jargon avoided or explained.
- Sincerity, honesty and ethics, with SEBI rules followed in letter and spirit. Recording interviews or client calls only after taking consent.