Equity analysts are best known by their buy, sell (or underperform) and neutral recommendations— perhaps till recently more by their buy refrains. However, one problem with the eagerness to put out buys is that it becomes difficult for fund managers to rate the best buys amongst the clutter of buys.
That’s precisely why global investment bank Merrill Lynch recently launched a new equity research rating model that attempts to be more performance-oriented. “In this model our objective is to rate a stock and not the company,” says Candace Browning, President, Merrill Lynch Global Research.The new rating system provides more transparency into analysts’ evaluation criteria, greater differentiation among the equity ratings within a cluster (for a buy or a sell). This new model is used by Merrill in various markets, including its Indian unit DSP Merrill Lynch. “Institutional investors like mutual funds and hedge funds are happy with the model,” says Browning, who developed the rating system.
Merrill uses quantitative techniques for this model and as a rule there have to be at least 20 per cent of the total stocks in the portfolio in the underperformer bracket. If there are five buys within a sector, then the model will help locate which is the best buy in this cluster with price as an important objective. But this is above the normal research an analyst does on a company or sector, says Browning. So now a fund manager can just see a report and will be in a better position to take a decision.
Merrill, for its part, is more than following the new system— reflecting the rough ride in equities globally, it has some 30 per cent stocks in the underperformer category (with 47 per cent as buys and 23 per cent at neutral). Browning is upbeat on the Indian companies and has plans to step up research in India, with an increasing focus on mid-cap and small-cap companies. The investment bank covered 94 companies in 1996; now it has 150 and has plans to reach 200 by next year. It’s already covering more stocks in India than in the other BRIC countries—60 in Russia, 80 in Brazil and 90 in China. Hopefully, the underperformers amongst them won’t stay that way for too long.