Two halves of one job
The fundamental research analyst's role has two parts. Research is obtaining all the necessary information to meet a set goal, objective or research question. Analysis is working through all the available information to arrive at a conclusion. Chapter 1 said the same thing in broad strokes; this topic is about where the information comes from and where the line of legality runs.
Why the annual report is a starting point, not an answer
A company's annual report is a treasure trove of information, but three things limit it. First, thorough insight into the business and its profitability takes a very detailed scrutiny of the report, and even then the information is often not adequate. Second, the report is published once a year, so what it contains starts becoming dated as time passes. Third, much of what matters about industry conditions and the broader economy is not covered in depth in the company's own filings.
So the analyst spends significant time researching all three lenses: the economy, the industry and the company. The syllabus lists the methods.
The one thing research must never collect
The research work must not involve collating insider information. In this context, insider information is price-sensitive information about a company that is not available to the public at large but sits with a handful of individuals closely connected to the company in some role, or with their relatives, who are privy to its confidential information.
During research an analyst will come across things the public does not know. That alone does not make them insider information. The test has three parts: insider information is material, it is non-public, and if it were published it would immediately affect an investor's decision to buy or sell the security. Whether a given piece qualifies depends on the source of the information (how reliable it is), its impact, and its certainty.
A CEO mentioning an acquisition proposal that has not been announced: insider information. Reliable source, high impact, high certainty, and it would move a buy or sell decision the moment it became public. An employee mentioning that the purchase department's workload has gone up: not insider information, even though it is non-public. It may hint at higher business activity, but on its own it is neither certain nor decisive.
Mosaic analysis
Analysts routinely gather information from many sources. Each piece may be insignificant by itself, but combined with other public and non-public pieces it can produce a critical insight. That is mosaic analysis, and the syllabus says plainly that it is acceptable.
The obligation that comes with it: analysts must be careful about whether a particular insight came from their mosaic or from being privy to a specific non-public price-sensitive fact. The first is research. The second is the thing chapter 14's insider trading regulations punish.
An option may describe an analyst who receives a single unpublished figure from a company insider and then "confirms" it with public data, calling the result mosaic analysis. It is not. The decisive input was a specific non-public price-sensitive fact. Mosaic analysis is the reverse: many small, individually harmless pieces adding up to an insight nobody handed over.
Ask three questions of the non-public item in the question: how reliable is the source, how big is the impact, how certain is it. A reliable insider, a large impact and a firm fact together point to insider information. A vague, indirect, low-certainty observation points to a mosaic piece.
- Research is obtaining all the information needed to meet a goal or research question; analysis is working through the available information to reach a conclusion.
- The annual report is a treasure trove but needs detailed scrutiny, is often inadequate, goes stale because it is yearly, and rarely covers the industry or economy in depth. So the analyst researches the economy, industry and company through experts, market research reports, secondary research and primary research (site visits, customers, suppliers, employees).
- Insider information is material non-public information that, once published, would immediately affect an investor's decision to buy or sell. Whether something qualifies depends on the source's reliability, its impact and its certainty.
- Mosaic analysis collates pieces that are individually insignificant into a critical insight and is acceptable. The analyst must be sure the insight came from the mosaic, not from a specific non-public price-sensitive fact.