Don’t Fall Short in Assessing and Influencing the Market’s View

This post covers this element(s) of GAMMA PI: #3. Make Accurate Stock Recommendations
Assess and Influence the Market's View

If you were playing blackjack and never looked at the dealer’s face-up card, you’d be missing a great opportunity to increase your odds of winning.  Unfortunately, too many analysts are doing the equivalent when they fail to assess and influence the market’s view.

When equity research analysts have conducted proprietary research and arrived at an out-of-consensus financial forecast, they often get lulled into thinking they have all they need to make a killer stock call, when in fact they’re still missing a key element.  I find the best analysts also assess the current market psychology around the stock to determine if it’s the ideal entry point.  In addition, once they make the call, they take the added step of influencing this market psychology to get the consensus to come around to their thinking.

Many analysts forget they operate in a market with human beings who make irrational decisions, which is why it’s so important to assess and influence the market’s view to have a successful stock call

Utilize all six of the steps below to improve your stock picking skills.

Ensure Ideal Entry Point (Step 3B of TIER™), Assess and Influence the Market’s View

StepDetails
Step 1:
Monitor trading data
  • Monitor trading data to understand the motivations of the current stockholders
    • Changes in the types of investors who own the stock (e.g. value, GARP, growth, momentum). This can be done with Bloomberg’s HDSM function and FactSet’s "Ownership" report)
    • Short interest
    • Company insider buying and selling
    • Movement of stock compared to company's debt yield or CDS spreads
Step 2:
Know consensus
  • Analyze the consensus estimate, specifically determining:
    • How many analysts comprise "consensus" (more than 1 or 2 in outer years?)
    • Are their estimates disparate or similar?
    • Are any estimates stale?
    • Does the consensus of the most accurate analysts differ from the overall consensus? Starmine has a SmartEstimate that does this automatically
Step 3:
Survey market sentiment
  • Assess market sentiment about the stock and sector (which is done by the best buy-side and sell-side analysts) by surveying experienced buy-side and sell-side analysts, sell-side salespeople, traders, and investor relations contacts. Investigate:
    • Biggest investor concerns (may or may not be critical factors)
    • Expectations that are above or below the published consensus
    • The names and types of stocks receiving the most/least attention (where is everyone spending their time and what’s being ignored?)
    • General view toward the market (bullish or bearish) and risk (risk-on or risk-off)
Step 4:
Avoid following the herd
  • Avoid the mind traps we've identified as "Following the herd" which include overreaction and momentum biases
Step 5:
Monitor technical indicators
  • Monitor technical indicators to the extent they provide a better understanding of a stock’s momentum (beware they will not predict inflection points)
Step 6:
Influence the market
  • In order to get the consensus' thinking to come around to the analyst's out-of-consensus view:
    • Sell-side analysts should publish their view and influence key market participants
    • If allowed by their firm, buy-side analysts should inform the most influential sell-side analysts of their thesis, but only after the buy-side analyst's firm has built a position in the stock

These steps above take time and effort, especially the first time when you’re learning how to find all of this information, but it raises the odds of making a better stock call.  Don’t make the common mistake of assuming the stock research is all that’s needed for a great call…it also requires understanding the motivations of the players who own and trade the stock.

If you’re interested in following how this skill fits into the bigger picture, it’s worth noting I introduced my stock picking framework in a prior post, which has two dimensions (procedures and philosophies) for each of the four letters of TIER™.  The “E” of TIER™, is for “Ensure the ideal Entry point”, which has two sets of procedures: 1) validating your view; and 2) assessing and influencing the market’s view.  The table above highlights the latter.  It’s also worth mentioning there is a post that covers the 7 philosophies for this stage of TIER™.

This Best Practice Bulletin™ targets #3. Make Accurate Stock Recommendations of GAMMA PI™, within our Pathway to Success Framework. Let me know if this Best Practice Bulletin™ helps and how I can improve upon this best practice. If you’re interested in exploring this topic further, AnalystSolutions provides equity research training with a specialized workshop to help Master the Stock Call Techniques of Highly Experienced Analysts

Improve you or your team’s stock picking and communication skills with our equity research analyst training tools, which includes workshops such as the one above, as well as our GAMMA PI™ assessment and one-on-one coaching.  Also, consider ordering the book that inspired the founding of AnalystSolutions and the Best Practices Bulletin: Best Practices for Equity Research Analysts.

©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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