For investors who have tried to surf the spectacular falls and rises in equity market in recent months (from one year ago the FTSE 100 first lost 38% of its value, then rallied from the lows in March by 43%) the obvious question to ask is ''who cares about one share's particular characteristics when markets hold sway?''
For the management of those individual companies with buffeted share prices, there might be a similar concern: “Should we promote and differentiate ourselves as individuals when the strength of the market current seems so strong that all will be swept in the same direction?''
The company that I run, Equity Development was founded over 12 years ago to help smaller companies communicate with investors. So I must confess to considerable bias when answering the two hypothetical questions above with a resounding YES! But let us review facts.
A brief summary of the benefits of Investment Research to the company studied would be:
(a) better liquidity for the shares so that any shareholder needing to sell would get a fairer price; and
(b) a better rating on the appropriate valuation metrics.
The latter will enhance the former and also enable the company to:
(i) raise money on better terms;
(ii) improve its ability to use equity to make acquisitions
(iii) avoid or resist opportunistic bids that grossly undervalue the company; and
(iv) provide attractive equity-related staff incentives that on balance generate more value for existing shareholders.
Despite recent delistings, failures and takeovers, we are dealing with a substantial universe: there are over 2,000 companies with a primary listing on the London Stock Exchange and AIM.
No individual can know all about one thousand companies, let alone two thousand; so most investors and investment managers rely on research carried out by analysts for information and advice. Usually, to protect themselves from the risk that a single analyst is biased or has overlooked some important factor, they will read research from all the analysts writing on a company/topic and may consult more than one.
While it must, in theory, be possible for an investor or investment manager to find out for himself all the data that an analyst presents to him/her, it would take an inordinate amount of time. And for anyone with a balanced portfolio, good investment research has an additional significant advantage in that the specialist analyst can understand the implications of a news item that are not perceptible to a lay investor.
Some investment managers will invest in companies where there is no, or inadequate, research. To compensate for the extra risk and poorer liquidity, investment managers require a higher expected return.
Equity Development sponsored a major research project on the benefits of investment research to the companies' shareholders by one of this country's leading experts on the Theory of Investment.
Even we were surprised by the results. The excess expected return to compensate for the lack or inadequate supply of research is 2% pa in low-tech sectors and 4% pa in high-tech sectors that investment managers do not understand. This is quite a lot given the standard view that the extra return for investing in equities rather than risk-free gilt-edged is 3% pa.
In terms of share price, that varies from sector to sector, but over the market as a whole, the average effect is that a company with no (or inadequate) research is priced roughly 25% lower than an otherwise identical company with some (or an adequate level of) research.
So don't cut that communications budget.
Andy Edmond, the author (with thanks to John Borgars) of this article, has been CEO of Equity Development for 5 years. Prior to that he worked at Kleinwort Benson for 16 years where he ran Global Equity Capital Markets.