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Fundamental Equity Analysis

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The Dow outperformed the NASDAQ after leg 2 of the Springsteen Tour. Conclusion: ... Pay attention to patterns in the markets. Always think: WHAT MOVES STOCKS? ... – PowerPoint PPT presentation

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Title: Fundamental Equity Analysis


1
Fundamental Equity Analysis
  • Chris Argyrople, CFA
  • Concentric Investment Management LLC

2
Humor Caution DLJs Springsteen Theory of the
Dow
  • DLJ noted in their April 17, 2000 research report
    that
  • The Dow outperformed the NASDAQ after leg 2 of
    the Springsteen Tour
  • Conclusion
  • 1) The Boss Rules
  • 2) Humor is Acceptable
  • 3) SOMETIMES IT IS MUCH TOUGHER TO DISCERN WALL
    STREETs BS THAN IN THE SPRINGSTEEN EXAMPLE

3
Why Take this Class?
  • Develop Rigorous Analytical Approach Towards
    Evaluating an Equity
  • Integrate Concepts from Corporate Finance,
    Accounting, and Strategy
  • Profit
  • Improve Thinking Skills

4
Where is the Market Going??
  • I have no idea where the Dow or SP will trade in
    the next year
  • Long Term earnings will drive stock prices and
    earnings have risen about 9 per year over time
  • This Class Forecast Results for Individual
    companies, not the market
  • IT IS A STOCKPICKERS MARKET GOING FORWARD, SO
    YOU ARE IN THE RIGHT CLASS

5
Allocate 1,000 between these 3
  • Company A P/E ratio 15, consensus growth
    estimate 17, analyst dispersion around consensus
    of 12, payout ratio 0.
  • Company B P/E ratio 2, consensus growth estimate
    0, (20 analysts all in agreement), payout ratio
    100.
  • Company C P/E ratio 10, consensus growth
    estimate 30 (20 analysts all in agreement),
    payout ratio 0.

6
Course Goals
  • Be able to thoroughly analyze a company
  • Learn how to Integrate all knowledge into a
    portable toolkit for analysis
  • Help Train the Next Peter Lynch -)
  • NOTE The great student will take the science to
    a higher level than the teacher

7
How/What Will You Learn?
  • Learn from Yourself, about Yourself
  • Learn from Classmates (dont minimize)
  • Learn from Professor
  • TURN MISTAKES INTO LEARNING
  • My Goal / Deliverable
  • Students can prepare a professional securities
    analysis by end of session
  • Destination is gt Interim Progress

8
My Finance Philosophy
  • Models are Important
  • Analysis augments Thought
  • Accounting is Important
  • Details are Key, but stop when you reach
    diminishing returns.
  • Logic and Thoughtfulness are more important than
    modeling
  • I would rather be Warren Buffet than Fisher Black
  • Strategy is Equally important as Finance

9
Two Approaches to Research
  • Traditional MBA
  • Do some ratios
  • Quick Answers
  • This Class
  • Sleuthing
  • Thought Logic
  • Analytical Models

EASY WAY
CORRECT WAY
10
What to Expect
  • Hard Work
  • Boring Data Gathering and Data Entry.
  • Modeling COMBINED with Logic. The Models will
    not give you the answer. I could give you a
    model right now, and you would not know what to
    do with it.

11
What I Expect
  • Lots of Hard Work
  • Plenty of Participation
  • Debate and Differing Viewpoints
  • More Hard Work
  • I Expect you to be Good at Both the Modeling and
    the Thinking. These are 2 different things.
    Example How do you Calculate this E(r)?

12
About The Markets
  • Market Timing is nearly impossible
  • The Last 15 Years have been Incredibly easy to
    make money
  • The Next 15 Years will be Stockpickers Markets
  • Thus, Fundamental Analysis
  • Quant models face a difficult future because, by
    definition, quant models eliminate efficiencies
    they exploit

13
Characteristics of Good Analysts
  • Intelligence
  • Cant be Taught, BUT it can be offset by other
    factors
  • Buffet is rumored to be a genius
  • Geniuses can see what others dont
  • Work Habits Work Smart Hard, Focus
  • Independent Thinking / Guts to Act
  • Experience Training
  • Learn from Mistakes, Be Open Minded
  • Passion For the Work

14
MODEL BUILDING
  • EDGAR (Elec. Data Gather. Retrieval)
  • Data Entry -- actuals from 10Ks 10Qs
  • Try to Pick Companies / Industries that have lots
    of data -- Data drives good fundamental models.
    Dont want to multiply last years revenue by 6.

15
Pick A Company / Industry
  • Pick Industries where Data is Available
  • Maybe you work in that industry
  • Want to Drive Revenue with Fundamental Data
  • Pick Something you Like
  • At my Firm, we like High Fixed Costs, Operating
    Leverage, Data Availability
  • DONT WASTE TOO MUCH TIME CHOOSING A COMPANY
    WILL LEARN FROM Your Firm, Classmates, Prof.

16
The Class Will Cover
1) Cash Flow Methodology Valuation 2) EVA TM,
Economic Value Added Model c Stern, Stewart
Co. 3) Strategic Management Valuation 4)
Industry Analysis
17
What Moves Stock Prices?
  • Rank These Items
  • Press Releases
  • Earnings Growth
  • Buyers in the Market
  • The Big Boys Mutual Pension Funds
  • Announced Stock Buyback
  • Splits
  • Dividend Increases
  • Change to a New Economy Business Plan

18
Pattern Recognition is Key in Stockpicking
  • Pay attention to patterns in the markets
  • Always think WHAT MOVES STOCKS?
  • What happens to Financials, Homebuilders,
    Retailers when interest rates rise?
  • Why are falling same store sales GREAT for retail
    stocks?
  • Need Many Mental Models To a Man with a Hammer,
    Every Problem Looks Like a Nail, Charlie Munger
    -- You need to draw on many experiences for
    successful investing

19
Introduction to Valuation
  • THE VALUE OF ANY INVESTMENT EQUALS THE PRESENT
    VALUE OF THE FUTURE CASH FLOWS TO THE BUYER
  • This holds for all Investments ? Stocks, Bonds,
    Real Estate, Beanie Babies etc.
  • i correct discount rate that reflects the risk
    of the cash flows

20
DCF Valuation
  • Discounting future cash flows to a present value
    is called DCF Valuation
  • DCF Valuation is ALWAYS CORRECT given the
    following assumptions
  • You can correctly forecast the Future (even many
    years out)
  • You use the correct discount rate

21
Problem with DCF Valuation
  • In 1977, I was in 8th Grade
  • Experts told us
  • The Russians will take over America
  • Oil was going to 100 a barrel
  • Computers will take jobs away from humans
  • By 1990 the 4 Day Workweek !
  • If you can Predict the Future, then use DCF and
    Drop this Course

22
Reasons for Fundamental Research in an Efficient
Market
  • KEEP YOUR JOB (1 Reason)
  • Develop E( r ) Forecasts
  • FIND OCCASIONAL INEFFICIENCIES ATTRACTIVE
    SITUATIONS (this is the real 1 Reason)

23
My Recommendation
  • Do Lots of Fundamental Research
  • When you have no alpha, diversify and keep costs
    low (index)
  • When you have alpha, throttle it. Remember, you
    are in school so you can get a high paying job.
    If you are worth the pay, you will reap the
    excess returns from your best ideas. Implement
    your best ideas in a big way. Are your Ideas
    Worth the Paycheck?

24
The Buffett Method
  • Put all your eggs in one basket, and watch that
    basket very closely.
  • Concentrated Positions (never less than 9 stocks)
  • Intense Research, Lots of Knowledge
  • Note A good Portfolio will be
  • Industry Diversified
  • Maybe have 30 stocks

25
Homework Due
  • Pick a company -- Domestic USA only
  • Build an equity model
  • At least 2 full years of historical data ( 8
    quarters Income Cash Flow Statem)
  • Full Year Forecast for Current Year (quarterly)
  • Short writeup and investment thesis
    recommendation (Buy or Sell)
  • Hand in on-time Hardcopy PLUS Optional email of
    model

26
Homework (continued)
  • Use trailing and forward ratios to formulate your
    investment thesis recommendation
  • Only most recent quarterly Balance Sheet (for
    now)
  • Dont worry youll get plenty of practice !

27
Textbook is Optional
  • The textbook is Optional but recommended
  • Distributed in class
  • Price 65 cash / check / your good word
  • Must order text via email
  • Length continually varies, but approximately 280
    pages

28
About the Instructor
  • Adjunct Professor (not full-time)
  • New Analyst 10 years at Fundamental
  • B.S. Engineering, Rensselaer Polytech
  • M.S. Finance, M.I.T. Sloan
  • 2 years Equity Quant Acadian Asset Mgt
  • 4 years Corp. Finance Ford Motor Co.
  • 1.5 years Asst. Port Mgr Atlas Investm.
  • 4 years Analyst PAR Capital Mgt
  • Co-Founded Delta Partners in April 1999
  • Co-Founded Concentric Investments January 2005
  • Analysis of this Career.

29
Instructor (continued)
  • Internships Travelers (foreign equity quant)
    Colonial (bond trader)
  • Willing to stay late after class to answer
    questions
  • Have difficulty finding people jobs, but you can
    always ask (my contact list is finite, but the
    students regenerate yearly)
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