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12/02/2015

Three Critical Steps for Extracting Great Insights (Step 3: Entice a Thorough Response)


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Insights1Have you ever found yourself going into a store or making a call for something you need only to be disappointed by the salesperson? As soon as the experience began to deteriorate, you probably had little interest in sharing your needs because you thought “let me just end this pain and find a better option.”

The problem here is the salesperson hadn’t developed good influencing skills which are required to entice the customer to share his or her needs.  As analysts, we’re “salespeople” because we need to sell the person we’re interviewing on the idea they will benefit by giving us the information we need. This post continues a 3-part series covering our ICE™ framework for effective questioning. Step 3 focuses on the “E” of the ICE™ framework, “entice a response.”

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The best equity research analysts utilize influencing skills in a manner that provokes others to want to fully answer the question. The tactics below can be used in an interview or email exchange. For face-to-face and phone interviews, try to construct questions in advance so your mind is focusing solely on their response (and not wondering what you will ask next).

Use Names and Adoration

  • Starting the question with the interviewee’s name (said in a friendly tone) can help promote the ego and thus compel him or her to feel obligated to provide a response. For example: “Jerry, why has NewCo’s (the company’s name) return on investment declined over the past two years?” Be careful not to overuse this tactic because it, if used repeatedly, can begin to appear disingenuous.
  • Play up interviewee’s level of experience or role within their firms to make them feel like not responding would expose their lack of knowledge: “Based on your 20 years of experience, would it be better for revenue to grow at double digits or to see the firm’s return on capital exceed 10%?”
  • If the interviewee works for the company being discussed, attempt to work the company name into the more important questions because it suggests the company is a leader in the field, and so the implication is that management must have thoughts on the topic. For example if meeting with Delta Airlines management: “As one of the three major carriers, how many new aircraft do you expect Delta to purchase next year?” 

Exploit Cognitive Dissonance 

“Cognitive dissonance” is the discomfort most humans have when holding two contradictory beliefs, a condition that can be used to your advantage. First ask the interviewee about a belief the interviewee holds and then follow with a question about a specific related concern. Cognitive dissonance compels interviewees to show how their actions are consistent with their beliefs.

  • For example start with, “Does management have a hurdle rate for investments?”
  • Presumably, after the interviewee responds “yes”, follow it with this question: “Does management review completed projects to determine if they exceeded or fell short of the hurdle rate?”
  • Presumably, after you receive another “yes” answer, follow it with this question:
    • “Why did the major oil sands project not generate the expected returns?” or
    • “Which major projects have fallen short of the hurdle rate over the past two years?”
  • Management will feel compelled to explain that its actions are consistent with its philosophy, which often leads to a more detailed answer than simply asking the last question in the example above.

Reference Other Credible Sources of Information

The interviewee often wants to be considered the smartest person in the world on the topic (which hopefully will be the case if you have great information contacts). With this in mind, bringing up the following can often lead the interviewee to provide a more detailed answer than if these other sources were not mentioned:

  • Competitor’s performance: “Why does XYZ (competitor to company being interviewed) spend less capital as a percentage of sales than ABC (the interviewee’s company)?”
  • Competitor’s disclosure: State that a competitor of the company has shared a specific piece of information with the hopes that this management will divulge the same piece of information (or at least provide information about where they stand relative to the competition). “When I spoke with XYZ (competitor to company being interviewed) last week, I was told their production was running at 100% of capacity. Are you experiencing the same?”
  • Respected Expert: Reference a respected expert’s view to tease out management’s forecast. For example, “Can you help explain why ABC (the interviewee’s company) is more optimistic than McKinsey Consulting’s report forecasting demand for this product to be relatively small for at least the next two years?”
  • Consensus: Referencing consensus can be a powerful tool to extract insights. For example, “Consensus appears overly optimistic to assume ABC (the interviewee’s company) can grow EPS faster next year than this year.”
  • Your forecast: If the above tactics are not applicable, reference your forecast. For example, “If I assume only modest growth in each of your divisions and average cost inflation, I arrive at EPS growth of 15% for each of the next three years, which is more conservative than management’s guidance.  Can you please help me better understand what I’m missing in my forecast?”

Question View Towards the Stock

  • Mention your internal portfolio manager or external clients have a concern that needs to get addressed: “Many of the PMs/clients I speak with have trouble understanding how the company will achieve a double-digit growth rate.”
  • Suggest you cannot get more positive without a better answer: “I’m not sure I can get more constructive towards your stock unless I can get more comfortable with management succession plans.”

Encourage Elaboration

  • Encourage the interviewee with terms such as “I see,” “Interesting…” or nodding (do not overuse the nodding or it will become disingenuous)
  • Specifically encourage the interviewee to elaborate with phrases such as:
    • “Can you elaborate?”
    • “Please tell me more.”
  • Use silence. When interviewees haven’t fully answered your question, pause for 5 seconds. Often they will feel the need to fill the awkward silence by elaborating further.
  • Restating the interviewee’s answer will often result in more detail (referred to as “echoing”). For example: “So the entire shortfall in the quarter was due to weather?”

Conclusion

If you’ve been following all three posts on the ICE™ framework, the exhibit below will hopefully help tie it all together. This framework isn’t overly complicated, but it requires time to effectively use these best practices in preparing for interviews and email exchanges.  After you’ve utilized the framework for five to ten interviews, it will hopefully become a natural process in your mission to extract the informed insights required for great stock picking.

If you’d like to learn more about this framework, AnalystSolutions offers an on-demand workshop that delves deeper: Generate Differentiated Insights Through Better Discovery, Questioning and Influencing.

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©AnalystSolutions LLC All rights reserved. James J. Valentine, CFA is author of Best Practices for Equity Research Analysts, founder of AnalystSolutions and was a top-ranked equity research analyst for ten consecutive years.

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