Many people have the title, ‘financial analyst’, but there are wide disparities. So what is a financial analyst? These financial professionals analyze everything from securities for investment opportunities to internal corporate operations to optimize efficiency. There are several different categories a financial analyst fits into including equity, credit and operations. Sometimes, the term analyst is used as a “rank” more than a specific job. Many front-office employees of major investment banks are referred to as “analysts” for the first couple of years, then they go on to become associates. Each of these positions has subtle differences, skill requirements and compensation structures.
What are the Different Types of Financial Analysts?
Equity analysts try and determine the intrinsic value of the stocks of publicly traded stocks companies. There is a wide variety of valuation methods used but they all are referred to as fundamental analysis, or analyzing financial data to quantify a valuation. This is done by analyzing the financial statements of the company which are the balance sheet, income statement and cash flow statement (or items that may not show up in the financial statements, called ‘off balance sheet financing’). This type of fundamental analysis is sometimes referred to as a “bottom’s up” approach. A top-down approach takes a more macro view and analyzes broader economic conditions like employment and GDP that could affect the economy or sector in particular.
Conversely, technical analysis relies more on chart patterns of the stock’s price and various measures of investor sentiment to predict the direction the stock will take. The end result of either analysis is the investment recommendation and a price target for the stock.
Ratings often come as Buy, Hold or Sell, when the intrinsic value is compared to the current market price. If the stock’s determined value is higher than the current trading price, it is a ‘buy’ and vice versa for a ‘sell’. Sometimes, the stock’s recommendation is related to a benchmark like the S&P 500 stock index. In this case, the ratings are Outperform (meaning the stock should perform better than the market as a whole), Market Performer (will perform the same as the market) or Underperform (perform worse than the market). For example, the analyst with an outperform rating has made an accurate assessment if the overall market has gone down but the stock price remains unchanged.
The research recommendations are provided to the firm’s customers, often high-net worth individuals or institutions such as a pension fund. These customers usually pay for the research indirectly through trading commissions generated from the call or through the account fees they currently pay.
The companies being rated are often also customers of the firm. They compensate the firm for the research coverage indirectly in various ways including underwriting fees, credit lines and mergers and acquisition advisory fees. Each of the firm’s departments will have teams of analysts who cater to the customers every need, for a fee.
An analyst working under an issuer-paid model is paid directly by the company for the rating. Many traditional investment banks simply don’t have the staff, or an incentive, to cover every publicly traded company. Consequently, many small and micro-cap companies are largely uncovered by traditional research firms. This occurs most often with very small-cap companies that are under the radar and looking for exposure. There are several issuer-paid research firms that will rate these under the radar companies.
The issuer-paid model is not without controversy. The analyst wants to be as impartial as possible when conducting the due diligence on the company, which is also a paying client. It’s hard to ignore the potential for positively biased opinions. But there are conflicts in traditional research coverage because of indirect compensation. In fact, the issuer paid model is the norm in credit analysis and is used by firms like Standard & Poor’s.
Some analysts try and determine the ability of an entity to repay its debt obligations. This can occur for companies or federal, state or local governments and municipalities.
Major rating agencies like Moody’s and Fitch rate a wide spectrum of debt offerings. These can be anything from the very short-term paper of a Fortune 500 company, an esoteric structured product, the revenue bonds of a county’s new toll road or a 30-year sovereign issue from a European nation. Here, credit analysts focus on the ability of the borrower to repay a loan within a specific maturity date, so the analysis uses comparatively less assumptions than equity analysis.
Credit analysis is also used for individuals and is often done by loan officers in a bank or a mortgage lender. They will look at a borrower’s ability and history of repaying debts. FICO scores are widely used as summation of a borrower’s credit history and determine whether they receive a loan and at what interest rate.
Many corporations employ analysts in their finance departments to assist in the firm’s operations. Related areas of focus are capital budgeting and operating efficiencies. There is less focus on securities analysis and more corporate strategy. This type of financial analyst position is more widely represented across industries and regions.
Popular capital budgeting analyses like Net Present Value and Internal Rate of Return to determine the viability of potential projects. This is becoming increasingly useful in the real estate sector as large, commercial projects are often projected and analyzed before commencement by both lenders and investors. Budget analysis and financial reporting are often also tasks of these financial analysts.
Operations analysis involves everything from planning, data analysis and performance evaluation. Data mining and ‘Big data’ analytics is one of the fastest growing fields increasingly used by companies. Quantitative analysts sort through mountains of data to identify trends and assess probabilities of future events. A deep understanding of statistics is a must for any ‘quant’.
What are the Required Skills and Credentials?
Due to the analytical nature of research, analysts tend to have stronger academic backgrounds with an aptitude (and interest) in crunching numbers. A MBA with a concentration in finance or accounting may be preferred. If interested in becoming an equity or credit analyst being a Chartered Financial Analyst, CFA, charterholder is highly coveted. Additionally, there may be regulatory licenses to obtain the equity or credit analyst, including the General Securities Representative (Series 7 exam) and the Certified Research Analyst (Series 86/87 exam if the analyst is not a CFA charterholder or passed level 2 of the CFA exam within the last two years.) But the skills needed to become an analyst go beyond academia.
In addition to the analytical requirements, communication skills are part of the job description. A sell-side financial analyst actually prepares and writes the research report for dissemination to clients so it’s important the analyst has written a well-reasoned and understandable argument to support the recommendation, including an explanation of the assumptions used in the analysis. An analysis without a clear, persuasive argument may not implore the client to act, which is often the goal of a research report.
On the buy-side, the analysis is more of a proprietary nature, meaning that it’s for internal use only and for the benefit of the institutions own capital. But the analyst must still be able to persuade the portfolio manager or investment committee to act upon the recommendation. Here, actual presentations are more prevalent, including slideshow presentations and infographics. Buy-side analysts often look at companies with a more critical lens so critical thinking skills are essential.
Whatever type of analyst job you’re striving for, a strong proficiency with computer software (especially building and updating financial models with spreadsheets) is essential.
What is the Compensation?
Many financial professionals have the title ‘financial analyst’ so compensation can vary widely. It depends on a number of variables including years of experience, general economic and market performance, the accuracy of the recommendations and revenues generated by the call.
The Bureau of Labor (BLS) lists the median pay of a financial analyst at $76,950 as of 2012 and is expected to grow 16% over the next ten years, above the national average¹. This compensation reflects the catch-all nature of the tile “financial analyst” that we alluded to earlier. Financial analysts may move into higher paying titles including finance manager, controller or portfolio manager after some years of experience. SumZero lists the average pay for professionals in the hedge fund industry as $409,826, including deferred compensation and bonus². So it really depends on which type of firm the financial analyst is employed with but being an analyst on the investments side is probably more lucrative.
¹Bureau of Labor Statistics, 2012
²SumZero quoted in Business Insider article “How much people make at hedge funds 2014”