Equity Research Interview Questions (with Answers)

Equity Research Interview Questions

If you are called for an equity research interviews, you can be asked any question from anywhere. You should not take this lightly as this can change your Finance career. Equity Research interview questions are a mix of technical and tricky questions. So, you need to have thorough knowledge in financial analysis, valuation, financial modeling, the stock market, current events and stress interview questions.

Let’s find out below the top 20 Equity Research interview questions that are repeatedly asked for the positions of equity research analysts.

This is a simple conceptual equity research interview question and you need to first mention the definition of enterprise value and equity value and then tell the differences between them.

 

Enterprise value can be expressed as follows –

• Enterprise Value = Market Value of Common Stock + Market Value of Preferred Stock + Market Value of Debt + Minority Interest – Cash & Investments.

Whereas, equity value formula can be expressed as follows –

• Equity Value = Market Capitalization + Stock Options + Value of equity issued from convertible securities – Proceeds from the conversion of convertible securities.

The basic difference between enterprise value and equity value is enterprise value helps investors get a complete picture of a company’s current financial affairs; whereas, equity value helps them shape future decisions.

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Can be classified as the most common equity research interview question. Here is the list of common ratios for financial analysis that can be divided into 7 parts –

#1 – Solvency Ratio Analysis

• Current Ratio
• Quick Ratio
• Cash Ratio

#2 – Turnover Ratios

• Receivables Turnover
• Days Receivables
• Inventory Turnover
• Days Inventory
• Accounts Payable Turnover
• Days Payable
• Cash Conversion Cycle

#3 – Operating Efficiency Ratio Analysis

• Asset Turnover Ratio
• Net Fixed Asset Turnover
• Equity Turnover

#4 – Operating Profitability Ratio Analysis

• Gross Profit Margin
• Operating Profit Margin
• Net Margin
• Return on Total Assets
• Return on Equity
• Dupont ROE

#5 – Business Risk

• Operating Leverage
• Financial Leverage
• Total Leverage

#6 – Financial Risk

• Leverage Ratio
• Debt to Equity Ratio
• Interest Coverage Ratio 
• Debt Service Coverage Ratio (DSCR)

#7 – External Liquidity Risk

• Bid-Ask Spread

• This is again one of the most common equity research interview questions. Financial Modeling is nothing but projecting the financials of the company is a very organized manner. As the companies that you evaluate only provide the historical financial statements, this financial model helps equity analyst understand the fundamentals of the company – ratios, debt, earnings per share, and other important valuation parameters.
• In financial modeling, you forecast the balance sheet, cash flows and income statement of the company for the future years.
• You may refer to examples like Box IPO Financial Model and Alibaba Financial Model to understand more about Financial Modeling.

If you are new to valuation model, then please go through this Free training on Financial Modeling 

• Financial modeling starts with populating the historical financial statements of the company in a standard format.
• Thereafter, we project these three statements using a step by step financial modeling technique.
• The three statements are supported by other schedules like the Debt and Interest Schedule, Plant and Machinery & Depreciation Schedule, Working Capital, Shareholders Equity, Intangible and Amortization Schedules etc.
• Once the forecast is done, you move to valuations of the firm using the Discounted Cash Flow approach,
• Here you are required to calculate Free Cash Flow to Firm or Free Cash Flow to Equity and find the present value of these cash flows to find the fair valuation of the stock.

This is a classic equity research interview question. Free cash flow to firm is the excess cash that is generated after taking into consideration the working capital requiremetns as well as the cost associated with maintaining and renewing the fixed assets. Free cash flow to firm goes to the debt holders and the equity holders.

Free Cash Flow to Firm or FCFF Calculation = EBIT x (1-tax rate) + Non Cash Charges + Changes in Working capital – Capital Expenditure

You can learn more about FCFF here

Though this question is asked frequently in valuation interviews, however, this can be an expected equity reserach interview question. FCFE measure how much “cash” a firm can return to its shareholders and is calculated after taking care of the taxes, capital expenditure and debt cash flows.

FCFE model has certain limitations. For example, it is useful only in cases where the company’s leverage is not volatile and it cannot be applied to companies with changing debt leverage.

FCFE Formula = Net Income + Depreciation & Amortization + Changes in WC + Capex + Net Borrowings

You can learn more about FCFE here.

Appearing for equity research interview? – Be sure to know this equity research interview question.

source: Bloomberg.com

In our industry, companies will announce a specific date when they will declare their quarterly or annual results. These companies will also offer a dial-in number by using which we can discuss the results.

• One week prior to that specific date, the job is to update a spread-sheet which will reflect the analyst’s estimates and key metrics like EBITDA, EPS, Free Cash Flow etc.
• On the day of declaration, the job is to print the press release and swiftly summarize the key points.

You can refer to this article to learn more about earning season

One of the technical equity research interview question.

• Sensitivity analysis using excel is one of the most important tasks after you have calculated the fair value of the stock.
• Generally, we use the base case assumptions of growth rates, WACC and other inputs, which result in the base valuation of the firm.
• However, in order to provide the clients with a better understanding of the assumptions and its impact on valuations, you are required to prepare a senstivity table.
• Senstivity table is prepared using DATA TABLES in Excel.
• Sensitivty analysis is popularly done to measure the effect of changes in WACC and Company’s growth rate on Share Price.

• As we see from above, in the base case assumption of Growth rate at 3% and WACC of 9%, Alibaba Enterprise Value is $191 billion
• However, when we can our assumptions to say 5% growth rate and WACC as 8%, we get the valuation of $350 billion!

This is a nontechnical equity research interview question. To ensure that there is no conflict of interest, “restricted list” is being created.

When investment banking team is working on closing a deal that our team has covered, we’re not allowed to share any reports with the clients and we will not be able to share any estimate as well. Our team will also be restricted from sending any models and research reports to clients. We will also not be able to comment on the merits or demerits of the deal.

Expect this expected equity research interview question. There are few common multiples which are frequently used in valuation –

• EV/Sales
• EV/EBITDA
• EV/EBIT
• PE Ratio
• PEG Ratio
• P/CF Ratio
• P/BV Ratio
• EV/Assets

WACC is commonly referred to as the Firm’s Cost of Capital. The cost to the company for borrowing the capital is dictated by the external sources in the market and not by the management of the company. Its components are Debt, Common Equity, and Preferred Equity.

The formula of WACC = (Wd*Kd*(1-tax)) + (We*Ke) + (Wps*Kps).

where,

• Wd = Weight of Debt
• Kd = Cost of Debt
• tax – Tax Rate
• We = Weight of Equity
• Ke = Cost of Equity
• Wps = Weight of Preferred Shares
• Kps = Cost of Preferred Shares

Trailing PE Ratio is calculated using the earnings per share of the past, however, Forward PE Ratio is calculated using the forecast earnings per share. Please see below an example of Trailing PE vs Forward PE Ratio.

• Trailing Price Earning Ratio formula = $234 / $10 = $23.4x
• Forward Price Earning Ratio formula = $234 / $11 = $21.3x

For more details, have a look at Trailing PE vs Forward PE

This is a tricky equity research interview question. Please note that it can happen but only in theory. Please see the formula below for Terminal Value

If for some reason, WACC is less than the growth rate, then Terminal Value can be negative. High growth companies may get negative terminal values only due to misuse of this formula. Please note that no company can growth at a high pace for an infinite time period. The growth rate that is used here is to a steady growth rate that the company can generate over a long period of time. For more details, please have a look at this detailed Guide to Terminal value

This equity research interview question is asked repetitively.

The ideal way to answer this question is to pick a few good stocks (large cap, mid cap, & small cap etc.) and pitch the interviewer about the same. You would tell the interviewer that you would invest $10 million in these stocks. You need to know about the key management executives, few valuation metrics (PE multiples, EV/EBITDA etc.) and few operational statistics of these stocks so that you can use the information to support your argument.

Similar types of questions where you would give similar answers are –

• What makes a company attractive to you?
• Pitch me a stock etc.

The basic reason for which the PE of the high tech company is higher is maybe that the high tech company has higher growth expectations.

• Why is it relevant? Because expected growth rate is actually a PE multiplier –
• [{(1 – g)/ROE}/(r – g)]
• Here, g = growth rate; ROE = Return on Equity & r = cost of equity.

For high growth companies, you must use PEG Ratio instead of PE Ratio

This is among the top 5 most expected equity research interview question. Beta is a historical measure which represents a tendency of a stock’s return compared to the change in the market. Beta is usually calculated by using regression analysis.

A beta of 1 would represent that the stock of a company would be equally proportionate to the change in the market. A beta of 0.5 means the stock is less volatile than the market. And a beta of 1.5 means the stock is more volatile than the market. Beta is a useful measure but it’s a historical one. So, beta can’t accurately predict what future holds. That’s why investors often find unpredictable results using beta as a measure.

Let us now look at Starbucks Beta Trends over the past few years. Beta of Starbucks has decreased over the past five years. This means that Starbucks stocks are less volatile as compared to the stock market. We note that Beta of Starbucks is at 0.805x

Another tricky equity research interview question. EBITDA stands for Earnings before interest, taxes, depreciation, and amortization. And EBIT stands for Earnings before interest and taxes. Many companies use EBITDA multiples in their financial statements. The issue with EBITDA is it doesn’t take into account the depreciation and amortization as they are “non-cash expenses”. Even if EBITDA is used to understand how much a company can earn; still it doesn’t account for the cost of debt and its tax effects.

For the above reasons even Warren Buffett dislikes EBITDA multiples and never likes companies which use it. According to him, EBITDA can be used where there is no need to spend on “capital expenditure”; but it happens rarely. So every company should use EBIT, not EBITDA. He also gives examples of Microsoft, Wal-Mart & GE which never use EBITDA.

This equity research interview question should be very simple to answer. There are few weaknesses of PE valuation even if PE is an important ratio for investors.

• Firstly, the PE ratio is too simplistic. Just take the current price of the share and then divide it by recent earnings of the company. But does it take other things into account? No.
• Secondly, PE needs context to be relevant. If you look at only PE ratio, there is no meaning.
• Thirdly, PE doesn’t take growth/no growth into account. Many investors always take growth into account.
• Fourthly, P (price of share) doesn’t consider debt. As market price of stock is not a great measurement of market value, debt is integral part of it.

This equity research interview question is purely based on economics. You need to think through and then answer the question.

First of all, let’s examine the first option.

• In the first option, the price of each product is being increased by 10%. As the price is inelastic, there would be the meager change in the quantity demanded even if the price of each product gets increased. So that means it would generate more revenue and better profits.
• The second option is to increase the volume by 10% by introducing a new product. In this case, introducing new product needs more overhead and production costs. And no-one knows how this new product would do. So even if the volume will increase, there would be two downsides – one, there would be uncertainty about the sales of the new product and two, the cost of production would increase.

After examining these two options, it seems the first option would be more profitable for you, as a franchise owner of KFC.

Even if you don’t know anything about this equity research interview question, it’s common sense that chemical companies spend a lot of their money into research & development. So, if one can look at their D/E (Debt/Equity) ratio, then it would be easier for the analyst to understand how well the chemical company is utilizing their capital. A lower D/E ratio always indicates that the chemical company has strong financial health. Along with D/E, we can also have a look at Net Profit margin and P/E ratio.

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This has been a guide to Equity Research Interview Questions. Here we provide you with the list of most common technical as well as non technical equity research interview questions with answers. You may have a look at these other recommended resources to learn more –

• Business Risk vs Financial Risk – Similarities
• Top 4 Types of Business Risk
• What is Financial Risk?
• Private Equity Services Offered in India
• Top Financial Modeling Interview Questions (With Answers)
• Valuation Interview Questions and Answers
• Top Private Equity Interview Questions and Answers
• Corporate Finance Interview Questions (with Answers)

Prepare well and give your best shot. All the best for your Equity Research interview!