The unfolding Adani – Hindenburg story is but the latest example of the role equity research plays in monitoring the behavior of publicly listed companies. And although courts of law in the relevant jurisdictions will be the ultimate adjudicators of what went wrong at Adani and who is to answer for these wrongs, the lessons should be clear.
In times of irrational, or rational, exuberance (Alan Greenspan), some investors may not perform due diligence on target investee companies in accordance with international best practices. If those investors have fiduciary responsibilities towards their clients and fail to spot red flags, then they have to answer for those failures.
A portfolio manager needs to ask two questions before committing funds to an investee target: Why should I invest in this company? And, why should I not invest in this company? Answers to these two questions are then risk weighted and a decision of “go” or “no-go” is arrived at. Risk weighting is in the eye of the beholder – we have different risk appetites and have different prisms through which we assess and price various risk elements. However, having a clear risk assessment process in place, and adhering to it, is part and parcel of fiduciary responsibility and proper due diligence.
If the target investee company is so skilled at hiding liabilities, then that company’s management needs to answer to regulators and investors. And if a regulatory lapse (a failure to properly enforce securities laws and regulations) was the culprit, then regulators need to answer to courts of law, and to the politicians who appoint them.
Companies that seek to list on public markets and collect monies from the average, relatively sophisticated or unsophisticated investor, are held to a different set of rules and requirements when it comes to disclosure and governance than privately held companies. In a way, that is the price a company pays when it chooses to list on a public market to raise capital and increase its value. If a company is not comfortable with such requirements, it should stay private and seek private equity investments instead.
First and foremost, an equity research report is a tool to communicate the equity growth story of a listed company, in both qualitative and quantities terms. It benchmarks the company’s reality and future prospects against an increasingly standardized set of financial and sector filters and valuation metrics, as well as macroeconomic and monetary models.
An equity research report may be commissioned by a listed company. Such a company may wish to market its shares with investment funds and an equity research report is a key communication piece that the listed firm uses as part of its investor outreach, along with press releases, investor calls and roadshows – all important Investor Relations (IR) tools. Typically, a company that commissions an equity research report will have the right to have the repot not published if it does not agree with its conclusions.
Alternatively, an equity research report may be prepared by a brokerage house to share with clients, mostly investment funds, in the hope of increasing stock trading. Regulators insist on Chinese walls between research and trading at brokerage houses to avoid conflict of interest situations and protect investors.
An equity research report may also be prepared by an independent equity research house, not affiliated with a listed company or a brokerage firm.
The goal of an equity research report is to come up with a recommendation for investors: “buy”, “sell”, or “hold” a particular company’s shares. Such a recommendation is based on a certain valuation methodology that arrives at a future target price – as compared to the current price of a company’s shares: the future target maybe less, more, or equal to the current price, thus informing investor behavior.
It is not uncommon to have more than one equity research report done on a particular listed company, with varying or contradictory recommendations and/or future target prices. It is up to the investor to read the reports available and make up their own mind.
In the Middle East and North Africa region, around 1,500 stocks are listed on Arab stock markets, with a market capitalization exceeding $4 trillion by end of 2022. Many of these companies are investment targets for international investment funds, as well as regional retail and institutional investors. How many of these listed companies are being covered by equity research reports?
One estimate puts the equity research coverage of MENA listed companies at around 20% of all listed firms in the region, with the majority of coverage focused on large GCC and Egyptian stocks.
Two MENA brokerage firms are active in preparing equity research reports on MENA listed companies – EFG Hermes and Arqaam Capital. Additionally, a number of international prime brokers cover some listed equities in the region, on a selective basis.
To my knowledge, there is only one independent equity research house in the Middle East North Africa region, and that is Tunis-based AlphaMENA.
As MENA’s capital markets continue to develop, at different speeds of evolution, more equity research will be produced on the region’s listed companies. More and more companies will welcome and seek such analyses as they increasingly appreciate the role equity research plays in helping them reach out to investors globally to increase capital and market their shares. More and more local investors, be they retail or institutional, will increasingly demand equity research to support their investment decisions. This, undoubtedly, is good news for all.
Disclosure: The writer represents AlphaMENA in Jordan and Iraq.