Did Claude Just Replace the Equity Research Analyst?

0:00So it has come up with a sell rating on Chipotle.

0:04Debs: Growth is increasingly bought from the existing estate. Just as a headline, I don't even know what that means. And I think sometimes it tries to mimic the language of analysts that I just don't understand anymore. This took probably the better part of a half hour, hour or something like that. But I imagine this is the product of weeks of work and research. There's one particular company where we put a buy recommendation out and the company went bust within six months. But yeah, I didn't always get it right. Welcome to all our listeners. Welcome to this week's episode of What's the Big Deal? Graham, please do, as usual, tell us what the big deal is this week.

0:41Debs: Today we're back in your world and we're talking equity research. So we're taking a look at an equity research report that you have had. Was it Claude? Claude, I think, this week pulled together. Claude, I'm back with Opus because my fable is a bit too token heavy. So I asked Lord to generate a research report. I gave it carte blanche on the company that it was going to use. And it came up with an idea for Chipotle. How do you feel about that, Graham? I'm interested. I mean, to be fair, I haven't looked at Chipotle as a business, really. I mean, I've looked at plenty of quick service restaurants over the decade I was investing money at Aries.

1:24Debs: No real strong views. So interested to see what this research report has. I mean, from a personal perspective, I'm not a huge Chipotle fan, to be totally honest. I'm sure that's like an unpopular opinion. That's blasphemy in our household. It's a firm favorite when it comes to takeaway. I mean, I think the thing is like I grew up where there were so many, so many Mexican options that were really good. Even some quick service ones when Chipotle came to be, I was kind of like, all right, like why? I don't really need or want this. So I don't really go that often unless I'm in the middle of nowhere.

2:00Debs: And that is the option. Okay. But it's fine. Interesting that you say that. Because actually, one of the things that's worth remembering when it comes to research and investment ideas is that the investment thesis is not based on whether you like or don't like the company. So in theory, you can absolutely adore Chipotle and come up with a buy or a sell recommendation because it's really an expression of whether you think investors should be buying or selling the shares because of mispricing in the market. And that's really important that we're clear on that. It's not an expression of whether you think it's a good or a bad company.

2:37It's about the investment opportunity.

2:39Debs: um exactly and also i do think it's a it's an important aspect of investing to try to sometimes just separate your own personal view on something from whether that's a good investment or not i remember having just plenty of investment committee discussions over the years where you can see you can see include including yourself right you bring in your own personal bias because you like something you don't like something it's like okay just because i don't like Chipotle does not necessarily mean it's a bad investment. It might be a bad investment for other reasons, but it's not because I don't like it because plenty of people do, obviously.

3:13Absolutely. And it's one of the things that we used to say when we are starting to initiate coverage, and we'll talk a little bit about maybe talk about that in a minute. But when you're basically providing your first recommendation on a company, if you start with a very neutral view and you start with, well, let's build the valuation. Let's understand the company. Let's build some forecasts and then come up with our recommendation right at the end because you're not then approaching it with kind of I've got this kind of this view that I want to express from the start that you know as you say could be very biased based on your own you know view of the business itself and it's it's very it should be that the recommendation is driven by the valuation the mispricing that you see in the market relative to what you actually think the company is worth so it really should be underpinned by valuation.

4:01And just on that point, when producing this report, I did ask Claude to build a valuation model to support it so that there's kind of richness in the numbers in the report. We're not going to spend time going into the Excel model, but we can definitely make that available as well. But what we're going to do is focus on the report, I think, in this episode, so we can just really understand a little bit about an investment thesis and the structure of a research report.

4:26Debs: Now, before we start flipping pages here, one thing I'm just, because this is not my world of it. I mean, I've read, you know, thousands of equity research reports, but I've never actually put one together. So one of the things I'm interested in is knowing, so when you are initiating coverage at an investment bank or, you know, wherever these reports are getting put together, what kind of information are you using that is, say, outside just the purely public domain? Because obviously this report, I assume, is put together by Claude, so it's going to pull whatever it can find on the internet, effectively.

5:01Debs: But are you also getting access to the company? Are you meeting with management? Does that happen in a public venue? Are there private meetings where you're asking the management team whatever questions you've got? What kind of information and access do you have that goes into a report like this? Yeah, that's a great question. And the starting point has to be that you are only using public information. You're not allowed to use inside information as the basis for your research report. But yeah, as you mentioned, Claude is just scouring the internet for very widely available information, whereas the analysts will have access to not necessarily private information, but they'll have access to, as you say, the management team or investor relations are the ones, probably the key contact at the company.

5:43They will be able to ask clarifying questions. the company can't provide information that's not public but they can clarify and that then helps the analyst to build their own analysis and insights and their own analysis is basically their own interpretation which they then include within the research report but yeah the sorts of information that the analyst will use is for example they'll have access to consensus forecasts and that they can then use to benchmark against their own expectations they'll have access to market research as well. So for Chipotle, that would be information on, you know, other restaurant businesses and the restaurant industry.

6:23There'll be read across from other companies within the industry. When you're an analyst that covers Chipotle, you'll be covering other food restaurant businesses as well. So you'll have read across from those. And then you'll have access to all the other research that's available within your own investment bank. So, you know, So you'll have access to economic research. You'll have access to other sectors where there might even be read across as well. So you're kind of filtering a lot, but bringing in lots of different sources together. And we always used to use the expression that you're joining the dots.

6:58And so those dots are all public information. But the way that you join those dots is a new view and a new interpretation that suggests that the market is maybe mispricing the company.

7:09Debs: Okay, so in theory, the big Sandy warning, in theory, the access to information for this report we pulled together shouldn't be vastly different from the access that an analyst would have. Of course, you've got access to internal resources like the economic indicators you talk about, but there will be public resources for that kind of stuff as well that can be drawn upon for this. For sure. Should it be in a similar kind of region, we're saying? Sure, absolutely. The difference is the analyst's overlay. It's their own analysis and expertise. One of the key edges that you have as a research analyst is that you'll build really deep expertise into a select number of companies that goes above and beyond what any buy-side investor would have.

7:58And actually, it's important that we draw that distinction. And so sell side research that exists within the investment banks and brokerage firms, and they are producing research for the buy side. Those are the firms that manage the money. And, you know, if you work on the buy side as an analyst, you will have, you know, be constantly scouring the market for investment ideas, but over lots of companies. And so you don't really have time to know every company in detail. whereas the sell side within the investment banks they will be covering maybe 10 15 company max and will know those in real detail be constantly monitoring the developments within that industry and and the economy and updating their views to the buy side and that helps the buy side to make their own investment decisions so it's a weird one because i always remember when i joined research i was like what's the point in having both sell side and buy side research isn't that just stupitation but it's more about kind of a filtering process you have the really deep research on the sell side and then kind of the overlay on the buy side that makes sense it also depends on what

9:00Debs: buy side shop and team we're talking about i mean because the the the stuff that i used to do was all generalists we didn't have any kind of sector experience and you know that's very much just volume driven based on what's happening in a private market opportunity comes in so so what do you think? Then you compare that to a more liquid investing role. And there it does make a bit more sense to have some separation by industry or however you want to carve it up. So I think about the work I used to do. And a lot of times I'd speak to the, say, the liquid credit analyst for a particular industry to say, hey, I'm looking at this private thing.

9:40Debs: You know this space a lot better than I do because that's what you cover. So what do you So what do you think? So you've got some separation, but it really depends on what you're investing in and ultimately how big the team is too. Yeah, for sure. Okay, so let's take a look at Chipotle. Yeah. Yeah. So the starting point I will say is that Claude came up with a neutral view, an equal weight rating. But I pushed back on that because I wanted it to be a little bit more interesting to talk about. So it has come up with a sell rating on Chipotle. I also pushed back on the title because it was the most boring title to note I've ever read.

10:16So it's come up with guac is extra, implying that it's overpriced and that you're basically paying a premium for not for guacamole, for Chipotle without actually getting anything extra for it. So that's kind of the kind of summary. And it's actually quite important, although we're not writing newspaper articles here when we're writing research, it does need to be attention grabbing and a really nice clear hook for your thesis, your view on the company. So a nice clear headline, a nice clear title is always helpful.

10:50Debs: So, Debs, what's the most interesting equity research title you've seen before? So we had some that were blocked. We weren't allowed to use song titles. We did go through a phase of using movie titles and I published one called What Lies Beneath, which was a great note, a forensic accounting note on a UK aerospace and defense company. So yeah, we used to have a bit of fun with the titles of the notes, if we could. Wait, why could you use movie titles but not song titles? I don't know. It was just these arbitrary rules that we had. And we weren't allowed to use any puns, which were kind of seen in any way as controversial or slightly edgy.

11:35I think somebody wrote a note on tax called the joy of tax um and they hummed and hard about whether that was about i think it did make it out that one so did they get fired for that one no they didn't and to be honest if you're going to write a tax note you've got to make it a bit exciting so you know trying to reference sex at the same time is maybe not bad but sex sells

11:56Debs: to be fair this one actually i don't i don't hate i think i think blog is extra is kind of fun so yeah so headline is important but also clarity of message we always try to make sure that you know particularly on the front page and as I say it's not a newspaper that you're writing but the front page becomes really important it's a crucial bit of real estate in your research note because it's often the only thing that gets read it's you know usually investors will just scan the front page and then move on and it's only if they really like your investment idea that they'll kind of go want to read even the next few pages and rarely the full note.

12:35So making sure the front page is really clear and has all the essential information on it is really important. And for that reason, you know, the investment banks, they'll have a very clear template for how a front page will look. And the example that Claude has come up with is not quite how ours would have looked when I was working at Barclays, but not too dissimilar. So what you tend to have right at the top is the ratings it's a sell rating your target price that's the price that you think the shares should be trading at and as you'd expect if it's a sell rating the target price here is below the share price the analyst is saying that they believe that the shares are overpriced and then you've got that downside of 15 that's just the percentage difference between the target price and the share price so if i was to sell the shares today at 33.68 and the shares re-rated that means repriced to the target price of 28.5, then I would lock in that downside as a gain for me, 15 % gain.

13:33So that just basically helps to give you some idea about the conviction there. You wouldn't normally expect a sell rating or if it's only 1 % or 2 % downside, it's not really worth it for that. You want a nice clear bit of downside for a sell rating and a nice clear bit of upside for a buy rating.

13:52Debs: Oh, so one thing just that kind of sticks out to me just literally in the top block here is that Chipotle's equity value is lower than its enterprise value. So it's got a net cash position. Why do we think a company this big, I mean, we're 40, 42, 43 billion dollars has zero debt? Yeah, it's interesting. And this is where I completely reveal my lack of knowledge about Chipotle as a business. But what I suspect is either that they have a lot of leases of their stores or I don't know how much of it's franchised as well so I don't know kind of you know how much debt the company actually needs so um yeah it it it is a bit unusual that the market cap is is higher than the enterprise value that's not usually the case yeah yeah yeah okay the other thing we've got so if we scroll down um we'll come back to the text on the left hand side but the right hand side margin is kind of all of your data and stats that you need to support the thesis So you've got the share price chart.

14:49That just gives you a nice bit of idea about how the shares have traded in recent months and years. And as we can see, there's been a big drop in the share price. And I think that's kind of tied into the thesis that we'll look at in a minute. And then we've got the key data, things like, you know, the 52-week range, the number of shares. That becomes really important, particularly for a sell rating. You want to make sure that there's good liquidity in the market because, you know, we've all heard about short squeezes where, you know, investors have shorted and there's not enough liquidity to exit that position.

15:21And then as we scroll down, we've got on the right hand side, the analyst estimates, their own forecasts for how they think revenues and particularly EPS, that's a key metric that analysts look at, how that will develop over future years. And that is compared to consensus. We have an idea there of the delta versus consensus. And actually, that's a really important one. And then just looking at that, maybe slightly unusual that this analyst forecasts seem to be ahead of consensus. You know, normally, if we're putting on a sell rating, we're more bearish than the rest of the market. And we actually don't see that there.

15:57So that seems a little bit surprising.

15:59Debs: Is part of this driven by, I guess what we don't have is a comparison of just the overall financials. We have an EPS comparison. So I guess, you know, there's there are a lot of factors that can go into managing eps right you can buy back shares to not artificially but actually actually increase your earnings per share so i wonder if i guess we need to know what what kind of forecast is going into all of that all that calculation to know really how we're doing versus the street absolutely absolutely but it is something that you know it's one of the first questions you usually get asked as an analyst when you put it on a buyer or sell where are you versus the market you know are you ahead or below consensus and as you say it's kind of the trickle through is it the revenue the ebit or ebit dollar level and then eps how does that kind of tie into your thesis as it were yeah okay should we dive into the thesis yeah yeah right so on the left hand side we've got bullet points which basically give you an overview of why the analyst has come up with this sell rating okay and so the idea is to convey in a succinct way as possible um what has led the analyst to view that basically uh chipotle is overpriced um now um i would say this is quite a verbose uh front page um what we like to do as analysts is you know usually you have two or three key points and there's actually five or six bullet points so I'm going to maybe focus on the ones which have got the one, two and three here.

17:37So they say here that every scenario, we can defend values at the shares below the market. So what the analyst or what Claude has done is build three scenarios, a bull, a bear and a base case scenario. And their argument is that even on all of those three scenarios, you still come up with a target price, which is below the current share price. So that provides quite a lot of conviction to the call. That's what we kind of like to see for a nice strong sell recommendation. The second one, I think this is really the crux of the thesis, is to do with the fact that, you know, as we saw, Chipotle's shares have dropped in value.

18:16It started to recover. And really, I think the price at the moment is, you know, the analysis suggests that the recovery is fully priced in and maybe a bit more compared with what we see at the moment. So it says the recovery is in the volume. So in terms of transactions and even in revenues, but the margins for Chipotle are still well below where they were a few years ago. So I think margins for Chipotle in 2024, they were at 28, 29%. They're now at, I think, 25%. So although we've got increasing volume... That's a big change. Yeah, it's huge. It's huge. And I think they've been really struggling with a whole host of things.

18:53A large amount of that was to do with a reduction in volume, a reduction in their revenues and as a company with quite high fixed costs, that immediately hits their margins. They've got operating leverage, which means that if you see changes in volume, it quickly feeds into their margins. We've now got the recovery in the revenues, but we're not seeing that in the margins. And the argument here is that the share price implies that we've got both volume and margin recovery, and we don't. So that, I think, is the crux of the thesis. The third point, as is usual, is maybe a little bit weaker, a bit more techie.

19:33It says the growth is increasingly bought from the existing ring of estate. There's some quite techie point here about to do with store openings there. But I think the core element is to do with the margin story and that we've got recovery without margin recovery.

19:47Debs: Yeah, it's funny. As we've been talking, I've been reading through that third point. And even I was like, what are we really trying to say here? Growth is increasingly bought from the existing estate. I don't, just as a headline, I don't know what that means. Joy, it's interesting you say that. I think just before we started recording, I was trying to read through this and some extra notes that Claude had provided. I was really struggling to understand some of the language used. And I think sometimes it tries to mimic the language of analysts. But it's kind of going a little bit beyond and using language that I just don't understand.

20:24Exactly.

20:25Debs: Because usually when you say, when you talk about buying growth, it means you're acquiring another business or new stores or whatever the case may be. but you don't really buy growth from your existing store status. It doesn't connect in my mind anyway. And I was reading through it and I'm like, I don't really know what this is saying. And that's an important learning point because to be honest, on your front page, you want to be left with no confusion as to what your thesis is. Your clients will want to argue the toss about whether or not the margins should be priced in or not. But what you really want is a clear sense of what you're trying to say.

21:04And that, I think, doesn't really come across here.

21:07Debs: No, no, exactly. So I think a few other things to highlight on this front page, and something that we always are very clear when we're training research analysts, is that it's all well and good to have a really strong thesis. But there's two other things that you really need to convey to your clients. Number one is catalysts for the call. And you can see that on the right-hand side of the note. A catalyst just is an event that triggers the re-rating, the repricing, of the shares it's when the market basically realizes you know that it was wrong um and so catalysts they can be just you know the next set of results and that's one of the um catalysts here is the next set of results um where you know if the margins continue not to show any recovery then that you know is a reinforcement of the thesis here um but you can get other catalysts as well it could be kind of investor days uh it could be external data points like uh for example um food cost commentary you know what's happening in terms of food pricing so you know anything that is you know in the ideally in the near term that is going to help confirm that you are right and the market is wrong that's what you're really looking for with a catalyst because ultimately if investors have to put their money on the table they want to know that there is going to be a repricing soon they're not going to be still sat here three years time with you saying i'm right the market is still wrong because that's three years that they've had the opportunity cost for the money on this bet that hasn't yet come good.

22:31Debs: And presumably on these on these catalysts, you are if you're if you're an equity research analyst, and you're covering 10 companies, you are participating in every single event the company puts on whether that's an investor day or a an earnings call, because you just have to know everything. Oh, yeah, it's completely a live thing. And in fact, you know, when you take on when you initiate on a stock, you're effectively saying I'm now actively constantly monitoring everything and anything that is relevant to this company and that I will respond updating my views as and when that happens yeah that you're basically it's a constant dynamic thing and it's not just a one-time oh this is my view and I'll come back to in two years.

23:15Debs: I wonder if that's something that is getting I would assume this is something that's getting easier with the advent of these kind of tools right because I think about the that style of analysis that I used to do when I was, say, a first-year analyst. And obviously, I was in equity research, but you're also covering companies effectively, right? So you have your Google News alert set up to say, okay, I've seen this company in the news. Now you can do that a lot more on a much more automated fashion. Or even doing work on a company saying, look through all the recent investor presentations, all the earnings calls.

23:53Debs: A lot of this is just easier and faster to do. But I guess one thing that's still one thing that you still miss if you're just, you know, kind of trawling through data is the, I think I like I would assume that there's an element of you kind of get to, you get to know the management team a little bit, you don't have a direct relationship with them, you know, their presentation style. And you know, when, you know, maybe you think maybe you think they're, they're bullshitting you or hiding something. So I could see actually listening to each one of these calls once a quarter being really important.

24:27Yeah, for sure. I mean, interesting on the point about the news flow, it used to be the junior on the team's job on most sector teams to come in every morning and read through the Google alerts and just basically decide, is there anything that I need to escalate here to the covering analyst? And yeah, all of that can now be completely automated. Likewise, we used to do a lot of scrutiny of earnings calls, the transcripts, understanding the language used by management, and all that sentiment analysis can now be completely automated as well. So I think in a way, it makes it easier to filter. But the downside is that it also makes it harder to have an edge, to have something new that no one else in the market has thought about.

25:11So I think, yeah, there is that. I mean, yeah, I guess it's a trade-off really, isn't it? I was going to say, know what hasn't gone away is the need to really understand the companies because um really you can do a huge amount of you know analysis using ai um it will be able to trawl through all the public sources uh but you know ultimately if you've got the history and the expertise and the knowledge you will be able to provide read across that no one else has provided that's kind of that that kind of industry expertise is so crucial now just on the on the note of earnings calls

25:44Debs: what's the you've listened to i assume thousands at this point what's the what's the craziest one funniest one have there been any any times you're like oh my god that was just that was just nuts um it's interesting so i not really so i don't think earnings calls for me are usually where anything particularly exciting happens you know they tend to be quite uh i think unless the company's really under pressure they tend to be quite formulaic um i have had i have listened to some Investor Day ones, which the company is trying to recover from a really tough time. And it's really clear that, you know, they're trying to put some positive spin on it.

26:24And that's not really hitting home with either investors or with analysts. So I would say that I find the Investor Day ones more interesting, if I'm honest. But yeah. And, you know, you know, I've definitely had situations where I've made calls which have gone completely wrong. There's one particular company where we put a buy recommendation out and the company went bust within six months. So yeah, I didn't always get it right. And on that note... You don't, you don't.

26:56Debs: I mean, yeah, like that's just the world we live in. Yeah, absolutely. And kind of on that note, at the bottom of the research report on the front page risks to the thesis. So ultimately, your thesis is based on a couple of two or three pillars that you think, you know, demonstrate why the market is wrong, you have to acknowledge sometimes that you might be wrong. And so you have to, you know, highlight for your clients, where the risks are in that thesis or risks that, you know, that basically that you've got things wrong. So it does say, you know, that probably the key risk here in this thesis is that they suddenly end up with their margins snapping back, recovering to pre, back to 2024 levels, that completely erodes this thesis.

27:40So you have to acknowledge that. And I think one of the more interesting risks are ones where, you know, you've done a load of research on a particular theme or issue. You're very confident that you're right on that. But there are other risks in the business which you haven't necessarily explored. I think a really good one that I remember was where there was a massive legal case a company was you know defending itself on we'd done a lot of work on the operational side but ultimately whatever our view was on on the operational side it would be completely wiped out if they weren't successful in defending themselves against this legal case so that was the big risk the thesis was that you know the results of that legal case so it's important that we we recognize that and then anyone on the buy side who wants to you know go with your investment call they can do their own work to reassure themselves on those risks

28:28Debs: Yeah, I mean, ultimately, this is what this kind of what's all about, right? No risk, no return, no risk, no reward. Like you're always you're always taking some kind of risk. And I mean, obviously, this is something I spent a lot of time thinking about over the years, because we can talk about at some point, the the kind of differences between the equity investment hypothesis and credit investment hypothesis. But on the credit side, you're really focused on downside protection. So what are the things that can go wrong here? And ultimately, you're not trying to say that these are not risks, right?

28:56Debs: because you have to take some. What you're trying to do is say, okay, I see them, I understand them, and here's my realistic real world view where if they all or some of them actually play out, here's what I think it means for my investment position. That's kind of high level, I'd say, of how I used to think about it. For sure. And I think that would be a great thing to cover in a future episode because as you say, the way that we approach things for equities versus credit is quite different. The scope of what you're interested in is actually quite different as well, isn't it? So I think this is really interesting, right?

29:33Debs: Because we have, we now have, I mean, this took probably the better part of a half hour, hour or something like that. But I imagine if you're doing this work as an analyst in an investment bank, this is the product of weeks of work and research, building models, doing research, all the stuff. Yeah. How far, how far away are you or how far do you think the way we are from being in a world where equity research is going to get replaced, where we're going to have fewer equity research analysts, where we're going to turn, we're going to turn to these tools and this kind of resource for this, this kind of work going forward.

30:11Debs: Based on based on your view of what this looks like, how far, how far away do we think we are from that, from that kind of world? Yeah, I mean, it's an interesting question. People have been talking about equity research kind of disappearing for a long time. There's been various regulatory changes about a decade ago. And just in general, the structure of the buy side has changed slightly. We've got much more passive investing than active investing these days. and you know there's been plenty of chat that you know equity research is just disappearing and it still hasn't disappeared but i do see that ai presents a big challenge uh you know or at least it changes the way that the sell side operates and it does allow much smaller teams and you used to have you know quite large teams it's very labor intensive crawling through results you just don't need that anymore you can have much leaner teams and you can have teams covering more stocks and I think there is still room at the moment for really good value-added research, but that requires expertise that, you know, really, you know your industry, you know your companies really better than anyone else on the street.

31:21That will help provide value-added research. And, you know, as I say, and that's the buy side who, you know, they don't have the ability to constantly know what's going on in every single company that's in their portfolio all the time. So it's really, I think there is still scope for sell side research to provide value to the buy side, but it does, AI does change the way that they operate, force the sell side to become a little bit more efficient about how they work.

31:48Debs: Yeah, in some ways you can see it being kind of an opportunity, right? You can just do, you can do more and cover more stuff with fewer, fewer resources. Maybe you're publishing a little bit more often than you used to. Maybe the, because obviously this is indicative of an initiating coverage report that's a lot more fulsome than, than a typical kind of update note. Maybe we'll see more, more fulsome notes on a regular basis, which I mean, because I remember when when i was a when i was in mna using these to put models together all the time and of course you're always looking for initiating coverage because you have the most comprehensive set of info yeah so maybe we'll just have better better and higher quality access to to sell side equity research that's beyond just the pure okay here's the update to our consensus eps estimate it's everything updated in a slightly more regular fashion.

32:40Maybe.

32:40Debs: Yeah. I do also wonder if it slightly gives an advantage to much larger research firms because the sort of joined up thinking that they can provide. I think we've seen some really interesting research on AI and data centers. And if you've got a research team that are able to, you know, talk to the credit analysts around their views on the financing for data centers, the economics team on economic growth you know the fact they can do that kind of joined up thinking across the firm I think really allows them to provide value in a way that maybe some of the smaller firms would struggle without that kind of richness of data and expertise we'll see we'll see I have to be really careful not to say this is the end of equity research I have a lot of yeah exactly that was gonna be the end of everything yeah okay so i think that brings us to the end of this week's episode and our deep dive into equity research reports i hope you've enjoyed this week's episode i hope you found it enlightening um and that's all for this week thanks for me and over to graham cool thanks everyone we'll see you same time here next week in the meantime take care