What Is a Channel Check?
A channel check is a method of independent stock analysis whereby company information is supplied by examining the company's distribution channels. Clients of the subject company are interviewed to see whether their purchases of the subject company's product or service has changed, increased, or decreased.
The distribution channel companies are also interviewed as to their perspective on how competitive the subject company's product is in the current environment and how their pricing compares. This information is then used to formulate an estimate for the subject company's sales revenue for the coming year and to determine the current valuation of the company.
- A channel check is when a financial analyst or third-party researcher gathers information about a company by having conversations with managers of businesses that utilize or sell the subject company's products or services.
- The analyst can also talk to vendors who supply the company with materials needed to make the company's products.
- Analysts perform channel checks as part of their due diligence in order to gather information before making a recommendation regarding a company.
How a Channel Check Works
Financial analysts and third-party researchers perform channel checks as part of their due diligence to gather information about a company. An analyst looking to place a value on a company may conduct a channel check by having conversations with direct managers of businesses within a sector or industry that utilizes the subject company's products or services. They may also interview vendors who supply the company with materials needed to make the company's products.
The advantage of a channel check is that it gives the analyst the potential for additional insights into a company's overall health and prospects. Many times when stock analysts provide ratings for specific companies, the company being analyzed supplies the information that is used to generate the ratings. This information can be in the form of financial statements, management presentations, or company press releases.
When doing a channel check, however, the analyst is using information that is not supplied by the company. Instead, the analyst is independently investigating the company's financial health by contacting its vendors and distributors for additional information that could shed light on the company's prospects.
Channel checks have come under scrutiny as regulators question whether such research should be considered insider information or legitimate research. The Securities and Exchange Commission (SEC) regulates illegal insider trading, which is when someone uses non-public, material information about a stock to buy or sell shares of that stock.
In a press release, the SEC states that while it is legal to perform a stock analysis through expert networking arrangements, it's not legal to trade on any material, nonpublic information the analyst may obtain while conducting the analysis. Should the analyst come across such information while performing a channel check, they have the duty to keep it confidential.
Example of a Channel Check
ABC Widgets, Inc. is the subject company for Bert, a research analyst. Bert wants to check on ABC Widgets' clients and distribution channels to get an estimate of how many widgets they're planning on ordering from ABC Widgets. Bert is doing this in order to project ABC Widgets' revenue for the coming year.
Bert calls Jack, a manager at ABC Widgets' largest client. He asks Jack about his company's plans for continuing to do business with ABC Widgets. He wants to get Jack's opinion on how competitively ABC Widgets is positioned among widget suppliers. Bert is doing a channel check.
The Bottom Line
Investment analysts use a variety of tools and methods to evaluate companies in order to make buy, sell, or hold recommendations. A channel check is just one of many tools an analyst might use as part of their due diligence process. The analyst will likely look at a company's financial statements, assets, liabilities, and price-to-earnings (P/E) ratio. However, a channel check is unique in that it gives the analyst an opportunity to gain insight directly from a company's vendors and distribution partners who are selling, using, or helping to manufacture the company's products.