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Key takeaways
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NOVEMBER 2014|Independent equity research: How we do it, and why it matters to investors
Margins
Balance sheet
Other factors
Product penetration in
existing markets
New geographic markets
New business segments
Product pipeline
Macroeconomic factors
Input or manufacturing
costs
Marketing or labor costs
Price increases
Conversion of earnings to
free cash flow
Acquisition possibilities
Return of capital to
shareholders
Management changes
Whatever the operative factor, being right about which one will be the main driver of future earnings gives the analyst a leg
up on finding an earnings surprise, whether to the upside or downside. As two Putnam-affiliated researchers have shown,
predicting earnings surprises can lead to powerful results (Figure 2). Breaking down the broad stock market, as measured
by the Russell 3000 Index, into quintiles of earnings surprise between 1991 and 2008, Figure 2 shows that stocks with the
largest positive year-over-year earnings increases relative to their forecasted earnings at the start of the year tended to
perform dramatically better than stocks with negative earnings surprises. Consequently, successfully predicting big earnings surprises and avoiding the largest negative-surprise stocks appears to carry big potential rewards. Finding an
earnings surprise early, before the surprise becomes a known quantity, can yield additional returns. Figure 3 shows how
the potential rewards increase with the length of the forecast horizon. Being accurate in forecasting the biggest positive
earnings surprises twelve months in advance, for example, could potentially deliver a much higher return than making the
same forecast only three months in advance of the relevant earnings announcements. Said another way, having an insight
too late can dramatically reduce an opportunitys reward potential.
Figure 2.Predicting earnings surprises can lead to powerful results
Average annual reward
(by quintile of earnings surprise, 19912008)
35%
21%
0%
11%
-14%
Quintile 1
Q2
Q3
Q4
Q5
59%
49%
38%
27%
13%
3 mos
6 mos
9 mos
Source: Sorensen, Ghosh, Rewarding Fundamentals, The Journal of Portfolio Management, 2010.
2
12 mos
15 mos
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Ferat Ongoren
Equity Analyst (global industrials)
There is a very small number of dominant players
in the global manufacture of commercial airplanes,
so many aerospace analysts stake their projections of industry health on the orders these
companies will receive, and, by extension, on the
strength of global GDP. But when you consider
that millions of parts go into the construction of
a single commercial jet and that these items are
sourced from hundreds of aerospace suppliers and
original equipment manufacturers (OEMs) around
the world, the industrys supply base takes on a
distinctly global character. As a result, to focus
exclusively on economic growth projections and
order data for the 600-pound aerospace gorillas
is to mistake the forest for the trees.
NOVEMBER 2014|Independent equity research: How we do it, and why it matters to investors
Differentiated research
Putnam has created a culture that values differentiated
thinking. We encourage independent views and
reward analysts for approaching stocks with unique
perspectives. Because we allow for opportunistic,
best-ideas research and focus on what matters for an
individual company, we free up analysts to spend more
time developing insights on the most powerful variables
that they believe are the key drivers of earnings growth.
Beyond this, there are a number of areas where experience tells us that we can anticipate the markets missteps
and consistently identify points where we can develop
a differentiated view. The consensus, when it reflects
short-term thinking or reactive, emotional behavior,
frequently extrapolates immediate market conditions
and thereby misses trend changes. This opens up opportunities for us to capitalize on some of the most powerful
drivers of a companys earnings growth potential.
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Neil Desai
Equity Analyst (technology)
Think globally
Sometimes an industry evolves beyond the research
model that covers it. Consider the case of financial
exchanges. Sell-side equity research in this area is
divided regionally between Asia, Europe, and the
United States, with little or no overlap. These regional
boundaries, while they make sense for research
specialization in other sectors, tend to ignore the global
nature of many companies in the financial exchange
industry.
Di Yao
Equity Analyst (technology)
Minute details in a companys publicly disclosed
financials are often not well accounted for in the
growth models of our competitors and sell-side
analysts. Tracking market share by geography in
the mobile phone market, for example, can give
us an edge on where the opportunities cluster or
are relatively rarer. To do this effectively and with
confidence, moreover, takes a globally collaborative effort.
The recent history of exchange consolidation highlights this issue well (Figure 4). In many cases, asset
managers who bought stocks of companies shown in
the 20002003 column of Figure 4 before these companies merged into or were acquired by companies in the
20042011 column made enormous profits for their
shareholders. But if in 2005 you were an analyst focused
solely on European exchanges, you might not have realized that the product mix of Euronext, a pan-European
stock exchange, tied in very well with that of the NYSE.
Consequently, you may not have anticipated that the
NYSE would buy Euronext two years later, generating a
significant return for Euronext shareholders. And again,
if in March 2012 you had asked a U.S. analyst whether
the Chicago Mercantile Exchange (CME) might be interested in buying the London metals exchange, he or she
likely would not have been able to offer deep insight. In
fact, the CME recently took part in a bidding war for the
London exchange, underscoring how regionally defined
research on exchanges is poorly equipped to anticipate
industry change.
NOVEMBER 2014|Independent equity research: How we do it, and why it matters to investors
Jacquelyne J. Cavanaugh
Equity Analyst (global exchanges,
asset managers, and insurance)
Some industries with a domestic focus are not
very fertile ground for finding an investment
surprise. Large U.S. banks are a case in point. While
there may be significant money to be made in this
area, there are fewer inefficiencies to exploit. In
other words, a significant amount of value can be
unlocked by focusing on less well-covered names.
Being familiar with that history can be a help in understanding dynamics in other industries today. Online
travel offers a good example. Companies in this area
have caused the swift obsolescence of brick-and-mortar
travel agents, and in some cases have risen from penny
stock obscurity to multi-billion-dollar companies in
less than a decade. For certain companies, 50% annual
growth for five years running has consistently surprised
to the upside; and the fact that online agents sit between
Internet and travel companies means that their business
characteristics and growth potential may not be well
understood by analysts without proper perspective.
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20002003
20042011
LIFFE
CME
BVLP
CBOT
Brussels
Amsterdam
Paris
Future
CME (Chicago)
Latin America
MILA
Bovespa
BMV
Euronext
NYSE
NYSE Euronext (New York)
PCX
Arc
Current
ArcaX
China
Shanghai
Shenzen
Hong Kong
Brut
Strike
Nasdaq
Instinet
India
Nasdaq
Nasdaq (New York)
Island
Vilnus
Mumbai
National Stock
Exchange
OMX
Stockholm
Helsinki
Rest of Asia
LSE
LSE-RI (London)
BI
Taiwan
Singapore
Indo
Bursa
DB
DB (Frankfurt)
Korea
Osaka
Nikkei
SWX (Zurich)
Madrid
Valencia
Barcelona
BME (Madrid)
BME
Bilbao
TSE
TSE (Toronto)
MX
ASX
ASX (Sydney)
SFE
Peru
Colombia
Chile
NOVEMBER 2014|Independent equity research: How we do it, and why it matters to investors
PUTNAM INVESTMENTS|putnam.com
# International
equity analysts
# Global equity
analysts
# Fixed-income
analysts
Total
Consumer
17
10
Financials
Health care
Industrials
Technology
Telecommunications
Utilities
Analysts
16*
18*
21
64*
20
18
21
68*
Sector
Small cap/convertibles
Total
As of 9/30/14.
1Sum of analysts will differ from total due to analyst coverage overlap.
2Includes emerging-market equity analysts.
Tenure + talent
In addition to significant home-grown talent, we
are proud to say that experienced analysts at major
firms attracted by our collaborative, entrepreneurial
culture have come to Putnam in recent years. We
are also proud to say that we take a special interest in
seeking out new talent with great prospects but relatively less experience. We want to fill our ranks with
critical thinkers, thoughtful risk takers, and passionate,
self-driven individuals people with a strong work
ethic and a clear desire to win, as well as a demonstrated
track record of success. The 20-year veteran who is well
known in the industry and the 5-year unknown but rising
talent are frequently put on the scales, and what can
easily tip the balance is talent rather than tenure.
Our goal is to strike the right balance between experience and insight, tenure and talent. Putnams equity
research organization includes many people with long
experience working in investment management, but we
are also interested in sourcing new talent candidates
who may have fewer years of experience, but whose
abilities and conviction suggest to us that they will
develop a strong track record of getting stocks right.
NOVEMBER 2014|Independent equity research: How we do it, and why it matters to investors
Figure 6.We look for the right mix of career and rotating analysts
100%
rotating
Insucient experience
Insucient relationships
with company managements
Always looking ahead
75% career
25% rotating
Signicant experience
Deep relationships with
industry contacts
Healthy infusion of new ideas
Active debate
100%
career
10
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NOVEMBER 2014|Independent equity research: How we do it, and why it matters to investors
Conclusion
In our view, the highest-quality research comes from
focusing on what matters most and finding a competitive difference. We intentionally do not measure the
quality of our research by the number of stocks we
follow. To us, this is a simple signal of valuing quantity
over quality or worse, a sign of thinking that quantity
means quality.
At Putnam, quality is everything, from the highly considered balance of tenure and talent we seek to sustain in
our research organization to the communicative value
of each research note that an equity associate or longtenured analyst distributes to colleagues at the firm.
We achieve the highest quality possible, we believe, if
we find the right stocks, correctly see the key drivers of
their earnings success, and pursue the handful of ideas
where we can build the highest level of conviction at the
firm. We emphasize that analysts should take a highly
targeted, efficient approach to their research responsibility to dig deeper into the handful of companies that
our research suggests offer the greatest potential for a
differentiated insight.
If we can develop differentiated insights on key drivers
on a consistent basis, then we can be in a better position
to generate meaningful outperformance. And that
while it is no formula for assured success is the best
way we know to meet or exceed the expectations of our
clients and shareholders.
Consider these risks before investing: International
investing involves certain risks, such as currency fluctuations, economic instability, and political developments.
Investments in small and/or midsize companies increase
the risk of greater price fluctuations.
This presentation or any portion hereof may not be
reprinted, sold, or redistributed in whole or in part
without the express written consent of Putnam
Investments. The information provided relates to
Putnam Investments and its affiliates, which include
The Putnam Advisory Company, LLC and Putnam
Investments Limited.
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