Understanding Research & Consensus in Capital Markets

Published research on equities by investment banks and brokers (the “sell-side”) has been around for decades. While the official beginning of sell-side research is challenging to pinpoint precisely, as a point of reference we note that the industry gold standard for performance assessment across research analysts (the business news publisher known as “Institutional Investor”) has been publishing its ranking of sell-side analysts since 1972. 

In the five decades that have followed, research and its role in the broader capital markets ecosystem has evolved dramatically due to significant changes in technology, regulation, and investment philosophy over the years. This article will explore the role that research plays in the current capital markets environment, how to interpret and understand “consensus” estimates, and how IROs can anticipate the impact that sell-side research can have on their company’s stock price.

Understanding the role that research plays in the capital markets ecosystem

Providers of equity research play an integral role in helping companies more effectively get their narrative out to the market, helping investors better understand specific securities and industries, and aid in both maintaining and feeding overall market efficiency. 

Firms providing research on public equities often employ a group of analysts that cover specific industries or sectors that are expected to be “experts” on the space. It’s important to note that having quality research published on a stock can be helpful in steering investors to the company while also adding credibility to your story and market narrative.

Distinguishing between paid and unpaid research

There is an important distinction to be made as it relates to paid vs. unpaid research in the market. Paid research is typically provided by independent research firms that receive a cash payment from an issuer in exchange for direct research (that usually includes an initiating coverage report, ongoing coverage, and a stock recommendation) published on their company. It is important to note that in the vast majority of cases paid research will be discounted by investors relative to unpaid research. However, there are a handful of independent research firms where institutional investors will pay them directly for their research on a stock/sector - though these shops are few and far between.

Unpaid research most commonly comes in the form of sell-side research published by an investment bank/broker. While research provided by these firms is technically “unpaid”, there usually has to be some type of economic motive (potential fees from future trading revenues, capital raises, M&A transactions etc.) in place for a firm to allocate resources to cover a company. With that said, there are three important advantages that most unpaid (sell-side) research providers have over paid research: 

1. The required systems and processes in place to raise capital if needed; 
2. A much broader audience to broadcast the company’s story to (for example, many investment banks have both institutional and retail audiences);  and,
3. Estimates that are picked up by major data providers which in turn form a “consensus” around key metrics and KPIs.

What is “consensus” and how do capital markets professionals use it to inform their view on securities and markets?

The term “consensus” within the capital markets industry refers to the calculated average for a specific data point taken from a group of contributing estimate providers (typically these are investment banks/brokers, though some independent firms may be included as well). Consensus estimates play an important role in setting market expectations and maintaining overall market efficiency.

Capital markets professionals utilize consensus estimates in a variety of ways and for a number of different reasons. Examples of these include using consensus to:

1. Benchmark against internal company performance;
2. Benchmark against peer company performance;
3. Understand market expectations around specific KPIs and communicate accordingly with the correct individuals if there are gaps.

How to prepare for revisions to consensus estimates and the impact it can have on your company

As we progress through upcoming earnings seasons and the myriad of earnings revisions that are likely to occur, it is important for investor relations professionals to understand how these changes can impact your company and its stock price. Before we discuss the different ways it can impact your company, it is important to note that as a management team you often have the ability to manage expectations ahead of an event that could lead to a significant change in consensus estimates, such as an earnings release, by providing up-to-date guidance or commentary on recent trends (commonly done via a press release or form 8-K). This can help to brace investors for bad news (thereby reducing the negative shock/surprise impact of a poor earnings print) or allow them to appropriately price in good news if performance is trending ahead of guidance and/or consensus expectations.

In terms of the way revisions to consensus estimates can impact your stock, the most immediate one is the impact it has on your forward metrics. All else equal, an increase/decrease in forward estimates will lower/raise (making your stock appear “cheaper” or “more expensive”) the forward multiples investors often use to value and assess your company. There is also the impact that material revisions to numbers can have on your company’s perception in the market. For example, consecutive quarters of earnings “beats” and “raises” can reflect positively on a management team’s ability to operate their business and forecast future performance. Alternatively, a significant unexpected miss during earnings has the potential to “spook” investors and can be challenging to come back from quickly if the messaging and justification is poor. 

Closing thoughts

While there are many different ways investor relations professionals can utilize research and consensus as part of their IR program, we recommend having a sound strategy in place that is specific to the factors that matter the most to your company. To conclude, having a strong understanding of how research and consensus can influence share prices and stock activity is critical to successfully navigating an ever-changing capital markets environment. 

At Irwin, we have a suite of solutions designed to aid you in your understanding of both research and consensus estimates via our R&E integration with FactSet and our Board Reporting offering under our Professional Services. To find out more about these two offerings please click here.