Ratings analysts assess and analyze companies or industries and make investment recommendations based on their findings. These recommendations include buy, hold and sell recommendations on financial instruments that include equity or debt investments such as stocks or bonds.
Additionally, ratings analysts provide an anticipated target price on a company's security in the near future. Analysts hold corporations accountable for their performance and promote corporate transparency, so analysts not only analyze the market, but help to keep it working, too. If you're inquisitive and possess good analytical thinking skills, this career path may be one worth considering.
A Ratings Analyst in Action
To illustrate how a ratings analyst operates, we'll begin with an example. Suppose that the stock of a Fortune 100 company currently trades at $25 per share, and a ratings analyst predicts a price target of $40 for the stock within the next four quarters. The analyst makes this prediction because he or she projects that, within the given period, operational improvement initiatives will materialize and global demand will increase. Assuming an investor heeds the ratings analyst's recommendations, the investor then has a general picture of when to sell this particular stock, at what price to sell it and why the stock has reached that price.
If the investor wants to hold the stock after it has reached $40, then he or she will have to look for additional drivers that will add value to the company going forward. Assuming that the stock has reached $40 because of implemented operational improvements and increases in global demand, the investor will have to find reasons beyond those of the ratings analyst. (See also: Becoming a Financial Analyst.)
The Analyst Community as a Layer of Accountability
Ratings analysts are useful to the economy because they add an additional layer of accountability in terms of performance and transparency. A company's management team will provide its own outlook for the company, the industry and the economy, while a ratings analyst will give investors a third-party assessment of the same topics. Just as management should do its best to provide an accurate outlook, it is also the analyst community's job to give accurate assessments and to have a healthy level of professional skepticism. Thus, Wall Street's analyst community serves as a mechanism for accountability outside of the company. One can argue that the other important mechanism for accountability is government regulation. (See also: Show and Tell: The Importance of Transparency.)
Within the company, management is accountable to its board of directors. It is good to know, however, that smart and discerning analysts outside the company grill management during conference calls. This can be comforting, because members of the board can be relegated to becoming nothing more than "yes men"—especially if they are appointed by powerful, influential or unscrupulous chief executive officers.
Importance of Arm's Length Objectivity
Unfortunately, there have been massive errors in analyst ratings. At Enron, for instance, there were huge oversights and crooked dealings regarding the state of the company. Even as this (now defunct) Fortune 100 corporation was suffering large losses and hiding huge liabilities, the analyst community failed to properly question and get sufficient answers from management. Enron eventually filed for bankruptcy, several of its executives went to jail and the employers of the analysts paid billions of dollars in fines for providing deceptive and fraudulent recommendations to investors.
Enron was rewarding analysts who provided incorrect and bullish recommendations on Enron stock, even as the company underwent severe financial distress. Enron's executives awarded the analyst's employers with lucrative investment banking and consulting business worth tens of millions of dollars. Such monetary incentives prevented analysts from providing objective investment decisions to the investing community. (See also: Ethical Issues for Financial Advisors.)
Earnings Estimates and Management Accountability
Ratings analysts also provide estimates on a company's anticipated future performance, such as quarterly earnings per share (EPS). Wall Street pays close attention to these earnings estimates—especially if the company being followed is a large corporation with billions of dollar in revenue—and companies are expected to meet them. Failure to meet earnings expectations usually results in diving stock prices, and the board of directors holding management accountable.
Chief financial officers and other key members of management often develop and maintain a good rapport with the ratings analysts who follow their company. Continuously exchanging information about company initiatives, industry developments and market changes is critical for congruent expectations to transpire. A particularly large disconnect in the operational, financial and economic outlook between management and the analyst community can lead to big gaps between the company's quarterly performance, earnings estimates and Wall Street's expectations. Such scenarios—if the drop in stock price is steep enough—can result in financial distress for the company. If its valuation drops significantly, the company could be forced to raise expensive capital in order to meet its various covenants and prop up its equity valuation.
Necessary Critical Skills
The ratings analyst field is one of the most highly competitive and visible professions on Wall Street, and it can also be one of the most financially rewarding. Star analysts at the major firms such as Goldman Sachs, Bank of America and Citigroup who focus on a specific industry can earn more than $10 million annually. These analysts are regarded as experts who possess a wealth of knowledge and insight into the industries they follow.
Critical skills include:
- Thorough Understanding of Business: Ratings analysts typically have an undergraduate or a graduate degree in business. Analysts have a theoretical and practical understanding of virtually all of the disciplines within business, such as finance, economics, accounting, valuation, marketing, organizational behavior and operations. These are helpful in assessing a company's historical and financial performance. To project future earnings and derive a value for the company's stock, analysts delve into the details of financial statements and industry news, and study topics such as revenue and costs by division, tax rates, industry trends, management expectations, competitive positioning, customer receptivity, pricing, investment decisions, effectiveness of sales channels, outsourcing initiatives, prospective liability issues, pension funding, capital expenditures and more. (See also: Should You Head Back to Business School?)
- Industry Expertise and Insights: As mentioned, analysts are subject-matter experts within a specialized industry, whether that is health care, energy, information technology (IT), telecom, retail or financial services. You have to possess almost universal credibility, respect and visibility within that industry—otherwise, why would a CEO want to interface with you, and why would investors consider your investment recommendations? After all, large sums of money are at play. Ratings analysts know all of the major players within a particular industry, understand industry trends, risks, competitive positioning between companies and the industry's high-potential products and services (as well as the duds).
- Communications Skills and Emotional Intelligence: Analysts have to possess superior communication skills and emotional intelligence to interface with C-level executives and the larger investing community. They also have to exercise a healthy level of professional skepticism. Management's version of the story can be filled with sugar-coated statements, and management might not want to disclose certain information that can be embarrassing, damaging to the current stock price or useful to competitors. During the Q&A session, there can be a healthy tug of war between analysts, who are trying to get important company information, and management, which may not have all the answers or may not want to disclose certain facts.
- Researching Abilities: Ratings analysts typically have many years of experience working within an industry, and become thoroughly acquainted with the major companies within that industry. Analysts at the large financial institutions generally have 10 to 20+ years of experience as a financial or security analyst within a particular industry. Ratings analysts can come from a variety of backgrounds, typically within a finance or economic setting (corporate finance, investment banking, hedge funds, valuations expert, to name a few), but it is the years spent studying companies and specializing within a certain sector that really hone an analyst's skills.
If you are thinking of a career as a ratings analyst, you should first work in finance at one of the major firms on Wall Street, or in the finance, corporate development or strategy functions of a Fortune 500 company in an industry that you like. It's important to note that competition is fierce for any of these jobs. A finance certification such as a Chartered Financial Analyst, Certified International Investment Analyst or Certified Public Accountant can be helpful in advancing your career beyond a certain level. Additionally, passing securities exams such as the Series 86 and 87 show others that you are a competent research analyst. A master's degree in finance or an MBA can also help in your professional advancement. These early strategies can position you to earn a spot as a securities analyst at a major firm, where you will get the chance to specialize in a particular industry and begin to earn your stripes.