pertanika j. soc. sci. hum. 5(2): 125-137(1997) issn: 0128

Pertanika J. Soc. Sci. & Hum. 5(2): 125-137 (1997) ISSN: 0128-7702© Universili Pulra Malaysia Press

A Survey of Methods Used by Malaysian Brokerage Finn Investment Analyststo Appraise Investments in Ordinary Shares

SHAMSHER MOHAMAD and ANNUAR MD NASSIRDepartment of ACCOlll1ling and FinanceFaculty of Economics alld Management

Universiti Putra \lalaysia43400, Serdang, Selangor, Malaysia

Keywords: investment analysts, fundamental analysis, technical analysis, beta analysis, earnings multiplierapproach

ABSTRAK

Kajian ini menjelaskan kaedah-kaedah yang digunakan okh penganalis pl'lahllran yang benugas denganfirma-firma broker di seluruh negara unluk menilai saham syarikat yang tersenarai. Lima puluh lujuh paraanalis pelaburan di sam pel dan mak1umat diperolehi melailli soal-selidik dan diikuti dengan temul'amahunluk mendapalkan penjelasan yang lerperinci. Penemuan bjjolll menunjukan para analis menggunakanlebih dari salU kaedah untuk menilai saham dan keadah anali,j, rllndamenlal lebih kerap digunakan. Paraanalis juga menggunakan jangkamasa tiga tahlln untuk memhlloll "amalan keuntllngan dan perolehan, lebihmemenlingkan perolehan perakaunan dari aliran tunai, merujllk kcpada banyak pllnca maklumat sungguhpunmaklumat kewangan syarikat yang tersirat dalam penyata kewangan yang telah diaudil diutamakan. Maklumalkualitatif diperolehi melalui lawatan ke syarikat dan perbincangan dengan pihak peng-lirusan syarika!. Padakeseluruhan, sungguhpun penemuan kajian tidak menampilkan salU kaedah penilaian yang khusus, ramaipara analis minat terhadap kaedah nisbah harga-perolehan sebagai kaedah untuk menilai saham syarikal yangtersenarai. .

ABSTRACT

This slUdy provides a broad description of the methods used by investmem analysts attached to brokeragehouses in Malaysia to appraise investments in the ordinary shares of companies. Fifty-seven investment analystswere sampled from all the brokerage houses in Malaysia and a mail questionnaire method was used to solicitthe required information. The findings suggest that the sampled analys!.s used a combination of methods toassess the value of shares, though the emphasis is on the fllndamenlal analysis. They use a three-year earningsforecast period, prefer accrual earnings to cashflows and use a variety of sources of information with theemphasis on financial information from audited financial statements. substantiated by qualitative informationgathered through company visits. In general, though the findings are inconclusive regarding the mostcommon methods used for share price valuation, the inclination is towards the earnings multiplier approach.

INTRODUCTION

Investment analysts perform three informationrelated activities: (i) private information search,that is they search for information that is notpublicly available; (ii) prospective analysis, whichallows them to analyse, process, and interpretinformation for the purposes of prediction, and(iii) retrospective analysis, where they interpretthe events after-the-fact. Generally, investmentanalysts may be categorized into two groups,either as portfolio managers who invest in their

.own right or as information intermediaries whoact as advisers to institutional and individualinvestors. Portfolio managers use the informationgathered from their own appraisal to maximizeportfolio returns subject to some acceptable levelof risk. On the other hand, information

intermediaries provide share appraisalinformation to third parties, and consequentlythey compete with other analysts in gathering,interpreting and disseminating financialinformation. Information intermediaries areusually expected to be more specialized in theiracquisition and analysis of information thanportfolio managers because of their role in theprovision of information to third parties such asother investment analysts and individuals whomanage portfolios (Arnold and Moizer 1984b).To fulfil the need for specialized information bytheir clients, intermediaries inevitably spendmore time and conduct more detailed researchthan portfolio managers.

Portfolio managers spend time monitoringthe composition of their portfolios, organizing

Shamsher Mohamad and Annuar Md Nassir

the trading of seCUrIues and ensuring thatchanges in their clients' preferences have beenreflected in the portfolios. The differences inthe role of portfolio managers and informationintermediaries suggest that the proceduresfollowed, the information required, the depthand the time spent on analysis differ, implyingthat they are a heterogeneous group.

Investment analysis involves determining thelevels of risk and expected return of eitherindividual or group of financial assets beforedeciding on the most profitable opportunitiesavailable subject to budget constraints.Investment analysts usually try to identifymispriced assets such as shares using fundamentalanalysis and determine the timing of trade usingtechnical and beta analysis. The competitionamong the investment analysts to gather, analyseand disseminate information inevitably leads tomarket efficiency, that is the prices of sharesreflect all available information on the shares.Overall, the literature (Latham 1985) indicatesthat the capital markets are fairly efficient tonumerous information sets though there arepockets of inefficiencies as markets areeconomically bu t not perfectly efficient. Therole of investment analysts in maintaininginformational efficiency in the capital market isimportant in terms of continuously providingthe essential information to be reflected in theshare prices.

Investment analysts with insight can indeedtransform public information into valuableknowledge for their clients. To form useful insightsthey need to solicit timely information fromcompany management, investment bankingcontacts and others who are close to the sourceof information. This network helps them to solicitinformation from a common database concerningthe general economic and firm outlook and mostcurrent analysis tools employed. The literature(Groth et al. 1979; Givoly and Lakonishok 1984)suggests that brokerage houses and investmentadvisory services do provide valuable investmentadvice to their c1ient~. The clients were reportedto earn positive abnormal risk-adjusted comparedto readers of more widely disseminatedinformation.

This study attempted to provide a broaddescription of the methods used by investmentanalysts attached to brokerage houses in Malaysiato appraise investments in the ordinary shares ofcompanies. Specifically, the following objectives

were identified: to gather details of proceduresadopted in appraising ordinary shares; to identifythe types and accuracy of forecasts used; to

investigate the sources, use and importance offinancial information in making decisions; andto ascertain the extent to which discussions withcompany management feature in the analysts'decision-making processes.

REVIEW OF LITERATURE

Arnolds and Moizer (1984a) studied the appraisalmethods used by UK investment analysts andconcluded that the primary analysis techniquesused were fundamental analysis and technicalanalysis; beta analysis was hardly used at all.Many analysts forecast some aspects of theperformance of the company or its shares suchas like earnings per share, pre-tax profit,dividends and price-earnings ratio. The mostinfluential sources of information are thecompany's financial statements and its interimresults as well as discussions with the personnelof the company being appraised. Despite theperceived influence of information provided bymanagement, most analysts appear to be scepticalabout management opinions.

Arnold and Moizer (l984b) extended theirstudy of UK investment analysts by categorizingthem into two groups, portfolio managers andinformation intermediaries. They found thatalthough there is significant difference betweenthe level of detail and frequency of analysisundertaken by the two groups, there is nosignificant difference in their approach to shareappraisal. Information intermediaries madegreater use of some information sources andmore frequently discussed with companymanagement whilst portfolio managers reliedmore on other investment analysts as a source ofinformation. Their attitudes towards thecriticisms of company annual accounts differ,probably due to their different objectives.

Brown et al. (1987) examined the relationshi p between financial analysts' forecastssuperiority and the firm's informationenvironment. They concluded that the ex antefinancial analysts' forecasts superiority is positivelyrelated to firm size and the extent of agreementamong analysts regarding the firm's futureearnings numbers.

Bhaskar and Morris (1984) examined theaccuracy of profit forecasts published in thecirculars of British stockbrokers, and identified

126 PertanikaJ. Soc. Sci. & Hum. Vol. 5 No.2 1997

A Survey of Methods Used by Malaysian Brokerage Firm Investment Analysts

several key variables which were expected tohave an impact on forecast accuracy. Theanalysts' forecasts out-performed those producedby simple prediction models, implying thatprofessional analysts tend to underestimate futureprofits for the periods under review.

Bjerring et al. (1983) evaluated therecommendations of a Canadian brokeragehouse by using a number of techniques. Theresults reveal that an investor following thexecommendations would have achievedsignificantly positive abnormal returns, even afterallowing for transactions cost. The recommendations were not "immediately" reflected in marketprices.

Forbes and Skerratt (1992) examined theevidence relating to the quality of investmentanalysts' earnings forecasts. They exploited anew data source which is able to identify theprecise day when the analysts revised theirforecasts and concluded that UK analysts'earnings forecasts are not fully anticipated bythe market.

Givoly and Lakonishok (1984) providedevidence that investors used analysts' forecasts asa reasonable proxy for the unobservable expectedearnings. The dispersion of analysts' forecastsseems to be an important measure of risk,shadowing traditional measure such as beta andreturn variability.

Groth et al. (1979) suggested that thebrokerage house's recommendations to itsindividual customers were genuinely valuable inselection rather than market timing, even afterallowing for transactions' costs and risk.

In their comprehensive survey of UKinvestment analysts, Lee and Tweedie (1981)concluded that of the many sources of availablefinancial information the annual and interimfinancial reports were extensively used,particularly the traditional profit and loss accountand the balance sheet. However, respondentsunderstood specific reporting practices and leastunderstood the principles. Company visits weregenerally regarded in the range of considerableto moderate influence on investment decisions.They reported that firms analysed and verifiedavailable financial information speedily.

In general, the literature suggests that themost influential financial information sourcesare the annual profit and loss account, balancesheet and the interim results. Also of importanceare the discussions with company personnel, the

chairman's statement and the statement of sourceand application of funds.

There are significant differences betweenthe behaviour of portfolio managers andinformation intermediaries. Portfolio managersundertake relatively brief analysis and analyseless frequently than information intermediaries,though a similar approach is used to appraiseshares.

There is also evidence that the marketresponse to forecasts of analysts based in abrokerage firm is less sensitive than that ofindependent analysts. This suggests that themarket may regard broker firm analysts asconstrained by agency problems, which reducesthe reliability of their forecasts of a clientcompany's earnings.

Analysts predict earnings more accuratelythan mechanical models, and managementforecasting performances are not superior tothose of analysts for companies where bothmanagement and analyst forecasts are available.

DATA AND METHODOLOGY

There are a number of methods that might beapplied to investigate the behaviour of investmentanalysts and the procedures they use inappraising ordinary shares of companies, suchas postal questionnaire surveys, structured andunstructured interviews, "laboratory" experiments, and structured and unstructuredobservations. Each has its own strengths andweaknesses, and no single method is likely to becompletely successful. In this study, a postalquestionnaire survey was used to obtain therelevant research information from investmentanalysts who work with the securities firms. inMalaysia. This approach allows the researcher toreach a geographically dispersed sample at arelatively low cost compared with personalinterviews and telephone surveys. In addition, amail questionnaire can be filled out wheneverthe respondent has time. Thus, there is a betterchance that respondents will take time to thinkabout their replies and perhaps collect facts thatthey may not recall accurately, which is crucialfor collection of qualitative data. Thequestionnaire was supplemented by interviewswhen necessary to ensure the accuracy andrelevancy of the information obtained. Althoughthe role of investment analysts as portfoliomanagers is somewhat different from that ofinformation intermediaries, this study did not

PertanikaJ. Soc. Sci. & Hum. Vol. 5 No.2 1997 127


differentiate their appraisal methods by theirdifferent role.

Fifty-seven investment analysts based in allthe brokerage houses in Malaysia were sampled.Each respondent was asked to provide generalinformation about the nature of his job beforehe was asked for more detailed information onseven general areas relating to the proceduresfollowed in making recommendations for buyingor selling of shares for listed companies.Information was sought on various aspects suchas the features of the respondent's workingenvironment; the frequency of the three methodsof investment appraisal used and their perceivedusefulness; the application of fundamentalanalysis; experience with forecasting techniques;sources, importance and interpretation ofinformation that may influence the investmentsappraisal; the procedures followed whenrecommending buying, holding or selling andthe respondent's discussions with the companymanagement to formalize decisions.

RESULTS

Of the 58 securities firms throughout Malaysia,15 did not maintain a Research Departmentand neither employed any investment analyststo advise their clients nor conducted analysis tomake investment decisions (if any advice wasgiven it was solely based on gut feelings). Of theremaining 43 firms, 63% replied to thequestionnaires sent to them. Only 19% werefemale respondents.

Analyst's Working Environment

The main characteristics of an average investmentanalyst's working environment are summarized

in Table 1. On average, the analyst was a maleworking in an organization which employed justover five analysts and had spent just over threeyears working as an analyst. The analyst devotedabout 84% of his working week to the analysis ofMalaysian equities and analysed about 45companies on a regular basis and a further 58each year on an irregular basis.

Investment Appraisal Methods

There are a variety of techniques used by analyststo estimate the value of shares. Table 2 revealsthat the primary share appraisal technique usedby the respondents is the fundamental analysisfollowed by technical analysis; beta analysis ishardly used at all. On average, most analystsused more than one method. More than 90% ofthe respondents almost always used fundamentalanalysis, 70% used technical analysis and 19%used beta analysis. This also implies that technicalanalysis is used as a supplementary tool by mostof those who use fundamental analysis as themain tool. Beta analysis is not a popular method,probably due to the analyst's lack of knowledgeon how to apply this tool, the ineffectiveness ofthis method in emerging share markets such asthe Kuala Lumpur Stock Exchange, which ischaracterized by high volatility, thin trading anda relatively informationally inefficien t marketcompared to the developed markets where thistechnique is well adopted.

The other informal appraisal methodcommon among investment analysts is 'gutfeeling'. These analysts usually do not conductany formal investment research and analysis tohelp them and their clients make investmentdecisions. They generate revenue for their

TABLE 1Features of the analyst's working environment

Mean Response Standard Error

Number of analysts employedNumber of years spent as an

investment analystPercentage of working week spent

analysing Malaysian equitiesNumber of companies analysed

regularlyNumber of companies analysed

each year on an irregular basis

128

5.4

3.3

84.3

44.7

58.5

PertanikaJ. Soc. Sci. & Hum. Vol. 5 No.2 1997

0.33

0.41

4.92

7.03

11.52

A Survey of Methods Used by Malaysian Brokerage Firm Invesunent Analysts

TABLE 2Frequency of use of methods of investment appraisal

Almost always Usually Sometimes Seldom Hardly ever Average*(96-100%) (66-95%) (36-65%) (6-35%) (0-5%) (%)

Fundamentalanalysis 26 0 0 0 96.2

Technicalanalysis 7 12 4 4 0 71.7

Beta analysis0 6 5 15 19.4

"Gut feeling" 13 0 0 0 0 98.0

*Responses are summarized as means, based on the midpoints of each frequency interval

TABLE 3Perceived usefulness of methods of investment appraisal

(5 point scale: I = extremely useful to 5 = of no use)

Fundamental analysisTechnical analysisBeta analysis

Mean Response

1.12.13.8

Standard Error

0.070.170.19

employers mainly through the execution ofcustomers' orders for securities purchases andsales. They usually charge a lower rate ofcommission and capitalize on larger market share,which do not desire any information input. Aquarter of the sampled brokerage firmsthroughout Malaysia are in this category.However, due to the competitive nature of thebusiness most firms in this category have expressedthe desire to set up a proper research departmentto meet the increasing demand for informationservice as a long-term strategy for survival.

The extent to which each share appraisaltechnique is used is consistent with its perceivedusefulness, as shown in Table 3. All respondentsviewed fundamental analysis as either 'extremelyuseful' or 'very useful' whilst the equivalentpercentage for technical analysis was 70% andonly 11 % for beta analysis.

Factvrs Considered in fundamental analysis

The factors considered by investment analysts inusing fundamental analysis are summarized inTables 4 and 5. When appraising a share by theuse of fundamental analysis, analysts consider an

average of about five years' financial results.Findings in Table 4 suggest that various financialratios, the estimate of 'true' value of the priceearnings ratio and the estimate of the marketvalue by applying price-earnings ratio to a forecastof next year's earnings were three most importantfeatures of the analysts' approach.

Ninety per cent of respondents estimatedvarious financial ratios almost all the time whenconducting fundamental analysis to help themanticipate future conditions and predict thecompany's future earnings and dividends. Ratiosgenerally show the relationship between financialstatement accounts, which is critical to thesuccessful application of the fundamental analysis.

Over 85% of analysts 'almost always' or'usually' attempt to estimate what a company'spresent price-earnings ratio should be, basedupon their evaluation of the past and futureearnings of the company. In addition, 80% ofrespondents used the estimated price-earningsratio to estimate the company's market \'alue.The discounted cash flow technique (net presentvalue) and the company's net asset value arealso important whilst the estimate of future



TABLE 4Factors considered in fundamental analysis

Almost Usually Sometimes Seldom Hardly Average*always ever

(96-100%) (66-95%) (36-65%) (6-35%) (0-5%) (%)

Various financialratios 17 8 0 88.2

Estimate of 'truevalue of PER 16 7 2 R3.5

Estimate of marketvalue by applyingPER to a forecastof next year'searnings 17 7 2 0 86.4

Estimate of futuredividend yield 8 10 8 0 56.8

Estimate of NPV offuture cash flows 5 10 12 0 0 70.4

Company's net assetvalue 9 3 15 0 0 69.7

*Responses are summarized as means, based on the midpoints of each frequency interval

TABLE 5Fundamental analysis: frequency of use of alternative asset valuation bases

Usually Sometimes Seldom

Historical cost balance sheet value 16 8 3

Value adjusted for current cost offixed assets and stock 8 14 5

Value adjusted for general purchasingpower changes 2 9 16

Value on realization 5 13 9

dividend yield was only used infrequently. Ingeneral, all the respondents followed the sameprocedure to predict company's share price bylooking at the overall view of a share and examiningthe factors that affect the value of the share.

More than 65% of respondents emphasizedthe earnings, compared to the market value,essentially the estimation of two key numbers:the normalized earnings per share and the priceearnings ratio. For both the normalized earningsper share and the price-earnings ratio, the growthrate and pattern of earnings and dividends arecrucial. If they knew the present level of earningsand the growth rate to be experienced over the

next period, the earnings for the next periodcould be estimated with a high degree ofaccuracy. By the same token, the centraldeterminant of the price-earnings ratio is theexpected earnings growth for the future.

The results shown in Table 4 indicate that74% of respondents used the discounted cashflow technique and cash flow analysis. Measuringa company's cash flow is a good way to estimateits economic income and the present value of anequity share's free cash flow provides a goodestimate of its intrinsic value. In estimating ashare's intrinsic value, many factors are evaluatedsubjectively and the three such factors identified



are the financial strength of the company (52%),managerial style (63%) and industry factors(37%).

Financial strength of the company includesthe intrinsic value of the company, the liquidity,operating profitability, gearing capacity and ahealthy balance sheet. Whereas managementstyle includes quality of management(management growth potentials, namely hasstrong managemen t), growth of the companyand its production capacity (the nature of thebusiness; its operations; viability and credibilityof current on going projects and prospective,future projects). The industry factors comprisethe degree of competition especially from firmsin the similar industry, expected outlook on therelated industry, future market conditions andenvironmental factors.

Table 5 shows that the most popular basefor asset valuation is the historical cost in thebalance sheet relative to current cost, realizablevalue and general price level. It could be that ifenough information is available and wellunderstood by users on current cost, realizablevalue and general price level, the base for assetvaluation may change.

Farewsts of Analysts\-V"hen appraising ordinary shares many analystsforecast some aspects of the performance of the

company or of its shares. Findings in Table 6indicate that the average forecast period is 2-3years and 85% of respondents felt that thislength of period is sufficient to give investorsconfidence regarding the performance andfuture prospects of the company. A longer periodis considered to diminish the degree of forecastsaccuracy.

Responden ts suggested that earnings arealmost always an important input when makinginvestment decisions. Among all the respondentswho prepare forecasts 'almost always' forecastpre-tax profit (100%), earnings per share (100%)and price-earnings ratio (100%). Subsequently,the forecasting of post-tax profit (96%) and preinterest profit (96%) are 'almost always' or'usual1y' conducted. This is consistent with theprevious description of the importance of priceearnings ratios in share valuation. Among theremaining factors, ratio of turnover to capitalemployed (only 63%) is of least important butdividends (82%) are a relatively important factor.The forecasts of dividends together with earningsprovide an estimate of the company's futuredividend cover and consequently the predictionof risk and growth which are important indetermination of the company's appropriateprice-earning ratio. The importance of theaccounting earnings numbers relative to cashflow forecasts suggests that the appraisal methods

How many months ahead are forecastHow often each of the following factors

is forecast: *(%)

Turnover (sales)Pre-interest profitPre-tax profi tPost-tax profitCash flowsDividendsEarnings per shareRatio of turnover to capital employedReturn on capital employedPrice-earnings ratioMarket value of the share

Table 6Features of analysts' forecasts

Mean Response

26.8

93.694.398.095.685.882.498.063.379.698.083.7

Standard Error

1.67

2.062.000.001.853.264.240.006.194.260.005.39

*Responses were given under five categories from 'almost always (96-100%') to 'hardly ever 0-5%', identical to

those shown in Tables 1, 3, and 7. The mean responses shown above are based on the midpoin ts of eachfrequency interval.



are biased towards accrual based earnings ratherthan cash flows.

Sources of Information

Analysts utilize various sources of information tohelp them make an informed investmentdecision. Seventeen possible sources ofinformation were identified and are listed inTable 7. The findings reveal that the mostimportant source of information is the company'sannual and interim financial statements,essentially the profit and loss account and balancesheet. The other sources considered importantare the statistical and information services,government industry statistics, companypersonnel, source and application of funds, andfinancial press (items with an average score ofbelow 2). The remaining sources of informationwere all ranked as being of considerable tomoderate importance for investment decisionswith the sole exception of employee newsletters.Such newsletters are seldom sources of primaryinformation, but invariably repeat, in a simplifiedform, data available in companies' annual reports

to shareholders, which explains the relative lackof interest in employee newsletters.

Malaysian analysts spent more time and effortin analysing quantitative than of qualitative data.The popularity of numerical data and statisticalanalysis is probably due to the tangibility of thenumbers and the easier interpretation andmeasurement of quantitative data than subjectivefactors. Moreover, it is readily available andconsidered a cheap source of information; someare even available free on a subscription basis.More important is that users can obtain accurateinformation on virtually all phases of the securitybusiness from the statistical and informationservices. The publications on industry statisticsare oriented towards the national economy andthe effects of its cycles and fluctuations uponvarious industries. Such information is extremelyuseful to the analysts in predicting the impact offuture movements of the economy on securityprices.

Among the qualitative informationrecognized as important was that obtained fromdiscussions with company personnel, which

TABLE 7Influence of various sources of information

(5 point scale: 1 = vital influence to 5 = no influence)Mean Standard

Response . Error Rank

Company's annual report:Chairman's statement 2.52 0.23 14Directors' report 2.70 0.21 16Balance sheet 1.48 0.15 3Profit and loss account 1.44 0.14 2Source and application

of funds 1.81 0.19 7Current cost data 2.07 0.21 11Value added statement 2.26 0.22 12Unqualified audit report 2.48 0.18 13Qualified audit report 2.00 0.19 9

Quarterly and half-yearly results 1.41 0.12 1Employee newsletters 3.81 0.21 17Government industry statistics 1.74 0.14 5Statistical and information

services 1.70 0.15 4Financial press 1.89 0.17 8Trade journals 2.04 0.18 10Company personnel 1.78 0.17 6Other investment analysts 2.56 0.14 15

Lee and TweedieRank*

4911

710

311

86

5

*Source: Lee and Tweedie (1981), Tables 39, 45 and 51. No entry indicates information not included in Leeand Tweedie study



revealed information for verification purposesand was not always readily available in publishedform at the point of discussion.

The source and application of fundsstatement has significant influence on theinvestment appraisal because it shows thesensitivity of the available cash flows to thecompany's business operations and helps planthe required financing and debt servicingcapability for additional investments.

Financial press reports provide a good sourceof background information for analysts seekingto assess a company's prospects as they reveal thecurrent information on earnings, which isimportant in ascertaining the expected futureperformance. In addition, the financial press isused to ascertain any 'hidden' (sometimes termed'surprising') information about companies; thatis, previously undisclosed information ofimmediate interest. These are the probablereasons Why many respondents scan sources ofinformation other than annual reports.

Other sources of information utilized byanalysts to appraise investment in ordinary sharesare chart trends, published information by orabout the company, latest news from KualaLumpur Stock Exchange (KLSE) circulars orKLSE announcements, newspaper cuttings,library, company prospectus, competitors,customers, and perhaps their own experience inthe sector. In general, all information sourcesare useful as stocks are information sensitive.

It is also interesting to know how theavailable information is interpreted and used inmaking decisions. First, the credibility of theinformation is determined before it is analysedand interpreted in relation to the company'sgrowth and profitability, expected future earningsand consequently a pro-forma earnings per shareand price-earnings ratio are determined andcompared with the current market determinedratios, historical trend, and the average ratios ofother companies in the sector and thecompetitors. Besides the quantitative information,analysts use their own judgement based on theirknowledge of the industry and discussions withthose 'in the know' about the company and theindustry to arrive at a decision on the potentialprofitability of the shares.

Overall, the reported financial informationin annual reports is considered the mostimportant source of information in appraisingshares of listed companies because of the

expected reliability of the audited statementsabout company operations, contains importantfinancial data and provides a basis of pastperformance to forecast future performance.

Investment Appraisal

The common practice of predicting a company'sshare price at some time in the future involvesestimating earnings for the current year andapplying an 'appropriate' price-earnings ratio tothe estimated earnings in order to predict futuremarket price. Comparison between predictedmarket price and current market price thendetermines the worthiness of the share from theinvestment's perspective. The differencesobserved were in the area of estimating earnings.Most respondents used the common approachto the selection of an appropriate price-earningsratio, considering the view of the company takenby the market over the preceding few years(29%) and the company's balance sheet (26%).Other factors considered were the industryaverage (which involved the comparison betweenparticular company and the average of othersimilar companies in the industry), historicalprice-earnings ratio of the company, liquidityposition, gearing ratio and growth prospects.Surprisingly, only 7% of respondents consideredprospective earnings, quality of earnings, riskinessand peer comparison as important variables forselection of an appropriate price-earnings ratio.

A majority of the respondents (over 80%)agreed that market sentiment is affected by the'quality' of the company's earnings. The qualityis measured in terms of stability of the earningsstream and hence lower risk. Companies withquality earnings will consistently get high ratingsand the positive market sentiment will ensure ahigh share price. Companies with low qualityearnings will have lower share price and a lowerprice-earnings ratio.

A majority of the analysts (85%) alsoexamined the previous and current priceearnings ratios of the firm under considerationand of other firms of similar size and business,mainly for benchmarking purposes to assessrelative performance of other industry players(valuation to the competition). Many analystsmade judgements about the likely future priceearnings ratio for the firm being evaluated basedon the forecasted future price-earnings ratio(normally two-year forecast). This methodprovides some form of future valuation of the



share which is then compared to the currentshare price. For instance, underpriced shareswould suggest poor management, laggardindustry while overpriced shares would suggest afast-growth share and/or manipulation byinsiders.

It should be noted that the analyst'sforecasted price earnings ratio may differsignificantly from the market's perspective. Over60% of respondents agreed, suggesting that thedifference could be due to differences in theinformation used, for example, the analyst'sestimation is based on the fundamental factorssuch as earnings prospects and growth ratewhereas market price-earnings ratio is estimatedbased on market sentiments and investors'expectations of the future earnings of thecompany. The difference could also be due tomanipulation of accounting information,inefficiency on the part of the market or wrongevaluation of company as well as differentopinions.

More than half of the respondents usedprice-earnings ratio (PER) to estimate thecompany's market value and compared it tohistorical company PER, market PER andindustry PER. Subsequently, 8 out of 27respondents used discounted cash flow valuation(i.e., net present value) and cash flow analysis.TypicaJly, asset backing such as net as~et valuation(for a property-based company), net tangibleassets (look at revised net tangible assets; revisedsuggests that the analyst made a revaluation ofthe company) and market asset value remaineda considerable element in estimating thecompany's market value.

Most analysts seem to prefer a microeconomicrather than macroeconomic approach inappraising company shares. The latter approachrequires extensive efforts in terms of collectionand interpretation of the information, and a wideprospective sometimes may not be applicable tocertain industries or companies.

The findings discussed in this section implythat the procedures for estimating earningsvaried considerably between analysts dependingupon whether the analyst is an 'analytical' or'artistic' type. An analytical analyst conducts adetailed analysis of the available financialinformation on the company and verifies thecredibility of the available information through]'eliable sources such as the company'smanagement. An artistic analyst, on the other

hand, follows no systematic forecastingprocedures and does not consider many microand macro variables other than annual reportsand refined gut feelings based on discussionswith company officials.

Discussions with Company Management

Two-thirds of the respondents (67%) discussedthe company's financial performance with itsmanagement 1-3 times a year and 29% of themarranged more frequent visits. Company visitsare also arranged when a major developmentoccurs in the company. Besides meeting withthe company management, 89% of analysts whodeclared that their organizations conductedcompany visits also met and discussed relevantmatters with other officials during such visits.

Company visits are conducted to ascertainthe quality of management, to examine thevalidity and accuracy of the forecasts, estimatesand assumptions made, to review the progress ofon-going and new projects, and to confirm thecompany's proposed business projects' state ofaffairs and the future plans of the company.The overall aim of a visit could, therefore, bedeemed to be an aid to the interpretation of thecompany's financial results by the constructionof a frame of reference of future expectations.Table 8 shows the frequency of thirteen items ofinformation that are provided by companymanagement during discussions.

It is interesting to note that the effects ofthe general economic climate were perceived tobe the most frequently (80%) mentioned itemby the company management during discussions,followed by long-term objectives and plans (79%),outlook of demand for the company's products(74%) and details of changes in product range(71 %). Only a few respondents soughtinformation on costs and margins data (42%),and changes in key personnel (45%) duringcompany visits. Most of the information solici tedfrom company management was not given on avoluntary basis as management providedinformation only to the questions asked byanalyst.

In essence, 52% of the respondents declaredthat they did discuss the investment decisionswith company management in their decisionmaking processes. Of these, 67% ultimatelyfollowed their own predictions after thediscussions (they were sceptical of management'sopinions). Another 18% of respondents tended



TABLE 8Frequency of provision of information by company management

Almostalways

(96-100%)

Usually

(66-95%)

Sometimes

(36-65%)

Seldom

(6-35%)

Hardlyever

(0-5%)

Average*

(%)

Details of changesin product range 6

Details of research anddevelopment projects 0

Long-term objectivesand plans 11

Changes in keypersonnel

Reasons for pasttrading performance 8

Reasons for balancesheet changes 6

Management commentson analyst's ownforecasts 4

Data on costs and margins 3Outlook of demand for

the company'sproducts 10

Current labour situationEffects of the general 8

economic climate 11Plans for future capital

investment 8Information on

competitors 4

13 4 4 0 71.1

12 10 3 2 56,9

8 8 0 0 78.7

6 10 5 5 4.5

9 7 0 3 69.2

8 10 3 0 66.6

8 12 2 1 62.48 9 7 0 42.0

11 3 3 0 74.0

8 8 2 1 69.510 3 3 0 80.6

14 5 0 0 62.2

6 13 3 53.1

*Responses are summarized as means, based on the midpoints of each frequency interval.

to follow the company management predictions,whilst the remaining 15% stated that both pa~ties'

predictions were taken into considerations.Specifically, a majority of these respondents(74%) declared that the earnings forecasts usedby them were often the result of the discussionsbetween the two parties. Besides meeting thecompany management, they (89%) also metwith other company officials to obtain extrainformation about the company.

Comparison with Lee and Tweedie's Study

The findings of this study are compared to thoseof a similar study in the United Kingdom by Leeand Tweedie (1981), who used a preparedquestionnaire to interview 136 senior investmentanalysts of financial institutions and 61 analystsof brokerage firms. The rankings from thesestudies (shown in Table 7) are remarkably similar.In both cases the most influential information

sources were the interim results, annual profitand loss account and balance sheet. Similarly,the discussions with company personnel, thestatement of source and application of fundsand financial press were also consideredimportant sources of information while theemployee newsletters were considered the leastimportant.

CONCLUSION

Most analysts almost always use fundamentalanalysis in appraising shares even when othertechniques are used. Fundamentalists usuallyprovide their clients with a wealth of details,which is believed to give the client thepsychological satisfaction that they are getting'value for their money'. Technical analysis isalso used by analysts, but to a lesser extent thanfundamental analysis; beta analysis is hardlyused at all. Fundamental analysis andtechnicalanalysis complement each other in the



sense that the former identifing the mispricedshare while the latter suggests when to trade onthe share. Beta analysis is primarily used by afew analysts for evaluation of portfoliomanagement performance.

Although much less popular thanfundamental analysis, technical analysis is usedat least sometimes by a vast majority of investmentanalysts. Assuming the market is fairlyinformationally efficient, stock prices will followa random-walk and technical analysis will not beable to help generate profitable investmentopportunities. However, technical analysis is stillpopular with investors, probablv because of thebelief in the economic viability of the tool asmarkets are only economically and not perfectlyefficient. As analysts and investors compete toexploit their common knowledge of a stock'sprice history, they necessarily drive stock pricesto levels where expected rates of return arecommensurate with risk, or what is commonlyknown as 'fairly priced'.

It is interesting to note that althoughfundamental and technical analysis are perceivedto be the principal techniques used by Malaysianbrokerage finn investment analysts, a vast majoritystill practise the gut feeling technique andprovide brokerage services to their clients withoutconducting analysis of relevant information.

Some fundamental factors were forecastedby analysts and essentially the three mostimportant variables of the analysts' approachwere the use of various financial ratios, theestimate of 'true' value of the price-earningsratio and the estimate of the market value byapplying price-earnings ratio to a forecast ofnext year's earnings. The procedures forestimating earnings, however, varied betweenanalysts, which makes it difficult to conduct acomparative analysis.

On average, investment analysts forecastfor two or at most three years ahead. Thisrelatively short period is regarded as reliablecompared to the normal period of five years,which is often considered too long for anyreliable estimates. The three most frequentlyforecasted variables of analysis are the pre-taxprofit, earnings per share and price-earningsratio, consistent with the perceived importanceof the price-earnings ratio in share evaluation.

Most analysts used accounting based earningsrather than cash flows to estimate the expectedvalue of a share. They did not view the assessmen t

and prediction of cash flows and some analystswere ignorant about discounted cash flowtechniques. A majority of analysts in this studycan be classified as 'analytical analysts' whousually conduct a detailed analysis and basetheir conclusion primarily on this analysis. Theothers can be considered 'artistic analysts' whounder take minimal analysis and base theirdecisions primarily on their uninformedjudgement.

Investment analysts made considerable useof many sources of available financial information. The most commonly mentioned sourceswere interim and annual financial reports,particularly, the profit and loss account and thebalance sheet. This implies that audited financialstatements playa prominent role in appraisal ofshare values.

Company visits were made by most analyststo assess the quality of the company'smanagement and future prospects of thecompany. Contrar\, to expectations, most analystsregarded these visits as relatively unimportant,ranking them oilly sixth in influence behindannual reports ~1I1(1 other sources of financialinformation. Thc Illost frequently discussed issueswere the effects of the change in economicclimate on the company's performance, longterm objectives and plans, outlook of demandfor the company's products, and details ofchanges in product range. This information isconsidered important for verification andinvestment decision within the analysts'organizations. Generally, company managementprovides information on an involuntary basis,that is only providing answers to qucstions askedby respondents.

From the efficient market tlll'ory point ofview, it is possible that even though the marketreacts quickly and in the right direction to newinformation the resulting prices might still befar off the true value, creating pockets ofeconomically exploitable inefficiencies. Second,even if market prices are set according to theshare valuation models recommended in theliterature, only a few analysts use those models.Consequently, the institutional investors by whomthe analysts are employed or the clients to whomthey make recommendations may be missingopportunities to make gains or to avoid losseswhen new information becomes available.

In conclusion, the findings of this studyprovide some insights into the methods used by



investment analysts in brokerage firms in Malaysiato appraise the value of ordinary shares. However,the findings are inconclusive on the issue of howrecommendations regarding a particular shareare arrived at. This requires direct obsen1ation,structured interviews and questionnaires forclarification purposes, which is the subject matterof on-going research.

REFERENCES

ARNOLD, J. and P. MOII.FR. 1984a. A survey of themethods used hI L'K investment analysts toappraise investments in ordinary shares.Acrounting and Business Reseanh 24: 195-207.

AR"iOLD,J. and P. MOIZER. 1984b. Share appraisal byinvestment analysts-portfolio vs. non-portfoliomanagers. Accounting and Business Research 25:341-348.

BIIASKAR, K.N. and R.C. MORRIS. 1984. The accuracyof brokers' profit forecasts in the UK. Accountingand Business Reseanh 36: 113-124.

BJERRI"iC, J.H., J. L\KONISHOK and T. VERMAELEN.1983. Stock prices and financial analysts'recommendations. loumal of Finance 1: 187204.

BROW:", L.D., G.D. R!CHARDSO:-; and SJ SCHWAGER.1987. An information interpretation of financial

analyst superiority in forecasting earnings.loumal of Accounting Research 25: 49-67.

FORI\ES, W.P. and L.c.L. SKERRATr, 1992. Analysts'forecast revisions and stock price movements.lo'urnal of Business Finance and Arcounting 19:555-569.

GIVOL)', D. andJ. L\KONISHOK. 1984. The informationcontent of financial analysts' forecasts ofearnings: Some evidence on semi-stronginefficiency. loumal ofAccounting and Economics1: 165-185.

GROTH, R., W. LEWELLE"i, G. SCIILARMUM andR. LEASE. 1979. An analysis of a brokeragehouse securities recommendations. FinanrialAnalysts loumal 35: 32-40.

LATHA~I, M. 1985. Defining capital market efficiency.Finance working paper 150, Institute forBusiness and Economic Research, Universityof California, Berkeley.

LEE, T.A. and D.P. TWEEDIE. 1981. The InslitutionalInveslor and Finanrial Informalion. The Instituteof Chartered Accountants in England andWales.

(Received 28 Februwy 1996)

PenanikaJ. Soc. Sci. & Hum. Vol. 5 NO.2 1997 137

pertanika j. soc. sci. hum. 5(2): 125-137(1997) issn: 0128

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