Do You Know the Key Ingredient Found in the Best Stock Calls?

Unique insight

Would you offer to cook someone rack of lamb if you had no lamb? How about offering to prepare chicken Kiev but you have no chicken? Presuming most everyone would note such an essential missing ingredient, I then ask: why are so many stock calls missing a unique insight?

I have reviewed hundreds of stock pitches and research reports that leave me asking “where is the unique insight?” Unfortunately too many analysts think that just because they discovered something interesting about a stock (e.g. Apple is innovative or Tesla sells cars that are in high demand), it’s not been picked up by the market, which rarely is the case.

 

Analysts known for making great stock calls always ensure they have this key ingredient

The Missing Ingredient: Unique Insight

Every great stock call needs a unique or “informed” insight that:

  1. Pertains to a Critical Factor – As I discussed in a prior Bulletin, to generate alpha, analysts should be focusing on just the 1-4 critical factors most likely to move a stock. For example, Tesla’s ability to increase production of existing models or introduce new ones is likely a critical factor for its success, whereas noting that McDonald’s is bringing back the McRib in select markets probably is not. The best calls are those where the unique insight pertains to a critical factor (otherwise it’s not going to move the stock).
  2. Is Out of Consensus – The insight needs to be out-of-consensus. As discussed in a prior Bulletin, it needs to be more than simply stating a stock will go up 15%, in tandem with EPS growth, when consensus has the same growth rate. Anytime you see analysts or PMs on CNBC explaining why they like a stock, subtract credibility points each time they say “As everyone knows…” (…the company has great margins; or …great management) because if everyone knows it, what unique insight have they discovered?
  3. Is More Accurate Than Consensus – When I was an analyst, one of my competitors would invariably be the low on the Street. When I saw him at a conference one time I asked about this and he said, “I do this purposely so I get all of the calls from clients looking for the bear case.”  This is an example of an analyst not seeking to be most accurate.  More often, the lack of accuracy is because the analyst didn’t verify an assumption with a knowledgeable, objective source of information (i.e. not just company management). Make sure to have this objective verification of your key assumption(s) before making the call. If you’re wondering where to get these, they usually come from your own unique information sources, data series or primary research, which I’ll address in more detail in an upcoming Best Practices Bulletin™.

While on this topic, I cannot more strongly discourage reliance on company management for this unique insight.  First, it’s not likely to be unique (because management would be required to share it with everyone) and second, management simply can’t be objective (its goals can be at odds with those of its investors).  Many years ago, I recall visiting UPS management at its Atlanta headquarters with six of its institutional investors, where we had a great day of meetings. After the meetings, while waiting for our flights at the airport, we all discussed how well the meeting went. Within a week the company pre-announced it would miss the quarter.  This isn’t to say UPS management is misleading, but rather illustrates that management in general cannot provide us unbiased out-of-consensus insights.

Before I conclude, I suspect there are some readers who will say they don’t have time to find these unique insights because they’re so overworked or following too many stocks. When I’ve heard this argument in the past, I’ve recommend analysts go to their marketing or sales departments to hear what clients are told when they ask “what makes your stock selection process so special?” I don’t actually expect the analyst to follow through on this recommendation, but rather to contemplate the dichotomy many firms face in terms of promoting to clients the depth of the firm’s research even when their analysts feel overwhelmed.

So next time you’re preparing to deliver the prime rib of stock calls to your investment committee, portfolio managers or clients, ensure it includes a unique insight…or run the risk you’ll be serving a turkey.

This Best Practices Bulletin™ covers the first four elements of our GAMMA PI™ framework:

#1. Generate Informed Insights
#2. Accurately Forecast
#3. Make Accurate Stock Recommendations
#4. Motivate Others to Act

©AnalystSolutions LLP All rights reserved. James J. Valentine, CFA is author of Best Practices for Equity Research Analysts, founder of AnalystSolutions and was a top-ranked equity research analyst for ten consecutive years

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