The Importance of Public Stock Analysis for Investment Bankers

By: Gerald Ross
July 3,2024

Investment Bankers provide Capital Markets Advisory

An investment banking practitioner is a capital markets advisor. The client hires an investment banker to provide expert capital markets advisory before and during a capital markets process. Investment bankers are not retail investment advisors and do not advise on individual stock selection. Therefore, for efficiency purposes, it is important for the investment banker to understand which pieces of public analyses are necessary for to support clients in deal execution.

Investment banking practitioners execute capital markets deals and are highly experienced at positioning businesses in the marketplace to attract investment dollars. Therefore, investment bankers need to allocate large time resources to relative valuation exercises. Investment bankers need to be keenly aware of (i) public competitor pricing and (ii) recent precedent transaction pricing. With respect to the public markets, investment bankers are less interested in company-specific daily pricing movements and extremely granular business details.

The rest of this article will highlight the important analyses to consider when examining public stocks from the perspective of an investment banking practitioner.

Publicly Traded Firms can be used as Industry Benchmarks

Investment bankers always keep a pulse on their client’s public competitors and recent activity within the space. The awareness of public competitors and recent precedent transactions is known as relative analysis and it is very important for valuation purposes. The practitioners should also have a high-level understanding of key attributes specific to the underlying companies that drive relative valuation analysis. For example, operating metrics, financial metrics, investment strategy, business strategy, risks, and product roadmap.

• Relative Valuation Analysis
  • Guideline Public Comparables
    • The bankers will collect a universe of comparable companies
    • The bankers will calculate the companies’ Enterprise Value (Equity Value + Net Debt), and then determine a trading multiple relative to its Revenue or EBITDA
      • This analysis shows how markets value comparable public companies
  • Precedent Transactions
    • The bankers will find a list of recently traded comparable companies
    • The bankers will review the deal’s purchase price (or enterprise value) and then try to determine how the market priced the target
    • Bankers usually separate deals between majority and minority transactions, because the pricing is slightly different when the acquirer wants to obtain control of the target (in a majority transaction)
      • This analysis shows how markets priced similar targets in recent deals
  • Benchmark Analysis
    • Relative analysis is a good benchmark for valuation guidance, but to truly understand valuation bankers need to gauge key company-specific details of the underlying comparables
    • Understanding key operating metrics or financial metrics further informs valuation guidance, allowing bankers to take a premium or a discount to the comp set
      • For example, there will likely be adjustments to the valuation if the client has a significantly different growth profile or margin profile relative to its public comparable companies
• Deal Structuring
  • Public comparable companies do not only act as a benchmark for the deal, but they also (usually) act as the largest strategic acquires in the sector
  • Therefore, bankers should have a clear understanding of important non-financial aspects of public comparable companies
    • Public companies disclose important information in their quarterly filings, including risk factors and management discussion and analysis (MD&A)
      • Business strategy and plans for future growth
      • Current and future competitive landscape and risk analysis
      • Possible indications of futre investment strategy
  • This is extremelyimportant information when going to market and negotiating deals on behalf of a client

What Investment Bankers should look for when evaluating Public Companies

Remember, investment bankers are not investment advisors. Therefore, the goal when analyzing public companies should be to extract the information that will best serve their client’s capital markets needs. The banker should have a simple understanding of the company’s background and size, the company’s recent stock performance, and the company’s high-level financials.

Background and size are important because the banker needs to ensure that the public company is a good comparable to the client. Usually, very large firms do more than one thing, therefore maybe only one business unit of the public company is comparable whereas the other business units are not. This is especially important when reviewing margin analysis, because a manufacturer has a different margin than a distributor. Also, it is also good to know the size of the company, measured in market capitalization (number of shares x share price).

 Recent stock performance is important because the banker needs to know how the company is doing relative to the broader markets. If there is a large delta between the stock’s year-to-date performance and the broader markets, then the banker should most likely have a high-level explanation on why. Maybe the overall sector is doing poorly, maybe the company missed earnings, maybe the company had a one-time legal issue. Regardless, the banker needs to be aware and needs to determine if the market’s interpretation of the stock should be applied to the client’s valuation.

High-Level Financial Analysis is important because the banker needs to know the financial metrics of the public competitor to properly understand valuation relative to the client. In other words, how will the banker comp the client versus the universe of public competitors? Does a small, private, high growth client deserve the same revenue multiple as a large public industry leader? The market will ultimately price the deal, but investment bankers need to be aware of public competitors, their underlying financial metrics, and how they are priced to help guide valuation expectations for both the client and potential acquirers.

Conclusion

The banker is engaged by the client as a capital markets advisor to manage and execute a capital markets process. The client expects the banker to be a capital markets expert, and therefore it is important for the banker to have a strong grasp on relevant past and present capital markets activity. This does not mean that the banker needs to be an expert in daily movements of individual stocks. Rather, to best serve the client the banker should have adequate awareness of two major items: (i) publicly traded comparable companies and (ii) relevant recent market transactions.

The Warren Fox Group does not provide investment advice or legal advice. The information provided above should be used solely for educational purposes.

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The Warren Fox Group