What it means
The job starts with understanding a business in depth. An analyst reads annual reports, listens to management on earnings calls, builds forecasts of sales and profit, and compares the company with its competitors.
The result is an estimate of what the company is worth and where its share price might go. There are two broad types.
Sell-side analysts work for banks and brokers and publish research for clients, while buy-side analysts work for funds, pension schemes and insurers and research for their own firm's investment decisions. Their incentives differ, because a sell-side analyst's employer earns fees from trading and deals, while a buy-side analyst is judged on investment results.
The usual output is a rating, such as buy, hold or sell, and a target price. The target price often comes from applying a sensible valuation multiple to a forecast, for example a price-to-earnings ratio applied to expected earnings per share.
Analysts also publish the assumptions behind their forecasts, so readers can disagree with them. Many analysts hold professional qualifications such as the Chartered Financial Analyst (CFA) designation.
They also work under rules that require them to disclose conflicts of interest, such as owning the shares they cover. Regulators in many countries control how research is produced and shared.
For a non-finance reader, analyst reports and ratings are useful but should not be treated as facts. Forecasts can be wrong, and optimism is common.
Businesses also care about analysts because their estimates set the market's expectations, and missing those estimates can move the share price sharply. Good research does more than pick winners.
It explains the risks, such as rising debt, weak customers or changes in regulation, and shows what would make the analyst change their mind. Readers who focus on those risk sections often learn more than those who look only at the rating.
In practice
Real-world examples.
Example
A sell-side analyst at a brokerage covers the retail sector and publishes a note after a retailer reports quarterly results. She raises her forecast of profit by 6% and keeps her buy rating. Her clients, including funds, use the note in their decisions, and the firm's traders call them to discuss the change in forecast.
Example
A buy-side analyst at a pension fund studies a bond issued by a shipping company. He examines its cash flows, debt levels and the value of its ships. He concludes the bond's interest rate does not compensate for the risk and recommends against buying.
Example
A corporate finance team hires a former analyst to prepare for a meeting with investors. She advises the team on which questions analysts are likely to ask about margins and cash flow. The team prepares clear answers and avoids surprises.
Formula
Calculation
Target price = forecast earnings per share x target price-to-earnings multiple
An analyst forecasts that a company will earn $4.00 per share next year and judges that similar companies trade at 15 times earnings. The target price is $4.00 x 15 = $60. If the shares trade at $50 today, the potential upside is ($60 - $50) / $50 = 0.20, which is 20%.Case study
Seen in the real world.
Falconer Beverages is a fictional listed company that had been rated buy by most of the analysts who covered it. When its finance director, Leila, noticed that costs were rising faster than expected, she knew the market's forecasts were too high.
She briefed the analysts through public channels on higher input costs and lower expected profit for the year. Several analysts cut their forecasts and ratings, and the share price fell 9% on the day. This is an illustrative story, but it shows how directly analysts' views shape expectations, and why Leila preferred an early and honest message to a nasty surprise at the results date.
Afterwards, Falconer's investor relations team added a short guide on cost drivers to its results presentation. The analysts found the information useful and the later forecasts were closer to the actual results.
Watch out
Common mistakes.
- Treating an analyst's rating as a guaranteed prediction. It is an opinion based on assumptions that may turn out to be wrong.
- Ignoring who employs the analyst. A sell-side analyst's employer may do business with the company covered, which can influence the tone of the research.
- Confusing a security analyst with an information security specialist. In finance the word security means a financial instrument such as a share or bond.
Questions
People also ask.
What does a security analyst do?
A security analyst researches companies and securities, builds forecasts and valuations, and recommends whether to buy, hold or sell.
What is the difference between buy-side and sell-side analysts?
Sell-side analysts work for banks and brokers and publish research for clients, while buy-side analysts work for investors and support their own firm's decisions.
How do analysts value a company?
They use methods such as discounted cash flow and valuation multiples like price-to-earnings, compared with similar firms.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%