Stock Analyst Program 2009 Farid Guindo    Kaushik Sudharsanam March 02, 2009
Agenda <ul><li>MIC Portfolio </li></ul><ul><li>Research Report Composition </li></ul><ul><li>Macro-Economic Analysis </li>...
MIC Portfolio
<ul><li>In the last 12 months our portfolio has fared better than the S&P TSX Composite Index by 10.61% and has lagged the...
Research Report Overview
Equity Analysis Techniques Top Down Analysis Bottom Up Analysis <ul><li>Investor starts analysis with global economics by ...
Research Report Composition <ul><li>The key to writing a coherent SAP research report is understanding and articulating an...
Evaluation Criteria  (1) <ul><li>Choice of industry articulated relative to other  industries that would be affected by th...
Macro-Economic Analysis
Macro-Economic Analysis  (1) <ul><li>Cyclical indicators are a useful tool for anticipating market movements as they help ...
Macro-Economic Analysis cont’d. <ul><li>An alternative approach to using economic indicators is to use them as directional...
<ul><li>Sourced to Wall Street Journal’s market data center.  </li></ul>Economic Calendar  Stock Analyst Program 2008
Stock Valuation Methodology
<ul><li>Valuation methodologies are not mutually exclusive and in fact are more effective when used to validate one anothe...
Valuation Methodology <ul><li>Determine the stream of revenue being generated </li></ul><ul><li>Derive weighted average co...
DCF- Methodology <ul><li>First determine WACC = D/V * R d  (1-T) + E/V * R e </li></ul><ul><ul><ul><li>- Use target (optim...
DCF- Methodology <ul><li>Determine FCFF’s each year using assumptions driven off of revenue </li></ul><ul><li>Determine TV...
Precedent Transactions, Basic Steps  <ul><li>1. Find historical take-overs in industry  </li></ul><ul><ul><li>Again, look ...
Relative Valuation, Basic Steps  <ul><li>1. Determine the target company’s EPS, EBITDA, or Sales for current year and poss...
Investment Styles
Summary <ul><li>Based on the stock’s intrinsic value </li></ul><ul><ul><li>- Low PE, P/BV, P/CF multiples </li></ul></ul><...
Value Investing: A Closer look <ul><li>Both Graham and Buffet are fundamental value investors who use long term strategies...
Ratios and Techniques; Value Investing Benjamin Graham Warren Buffet 1. Sourced to John Reese, Todd Glassman; “Market Guru...
Buffett’s Due Diligence First Stage Analysis <ul><li>Take a look at the nature of the company’s business </li></ul><ul><ul...
Second Stage Analysis <ul><li>Determine if the company is priced appropriately  </li></ul><ul><ul><li>Step 1 . Calculate I...
Second Stage Analysis Buffett’s Due Diligence cont’d <ul><ul><li>Step 4 cont’d .  </li></ul></ul><ul><ul><li>- Use the pro...
Growth Investing Time Horizon Risk Level Effort <ul><li>“ Buy High, Sell even Higher!”, according to O’Neil the best of br...
Growth Investing cont’d William O’Neal <ul><li>In addition to his “growth metrics” O’Neal also looks for potential catalys...
Value versus Growth 1. Sourced to Bloomberg Financial. Both Value and Growth index are from BARRA.  Relative Price Perform...
Value versus Growth Time Horizon Risk Level Effort <ul><li>Lynch combines growth and value strategies in his investment th...
Against Conventional Wisdom Time Horizon Risk Level Effort <ul><li>Dreman goes after out of favour companies whose stock h...
Against Conventional Wisdom cont’d David Dreman 1. Sourced to John Reese, Todd Glassman; “Market Gurus.”  Stock Analyst Pr...
Appendix
Important Ratios Activity Ratios Liquidity Ratios 1. Sourced to CFA institute, Financial Statement Analysis.  Stock Analys...
Important Ratios Solvency Ratios Profitability Ratios 1. Sourced to CFA institute, Financial Statement Analysis.  Stock An...
Important Ratios Performance Ratios Coverage Ratios 1. Sourced to CFA institute, Financial Statement Analysis.  Stock Anal...
Resources Stock Analyst Program 2008
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  • Winter Presentation,Final(2)

    1. 1. Stock Analyst Program 2009 Farid Guindo Kaushik Sudharsanam March 02, 2009
    2. 2. Agenda <ul><li>MIC Portfolio </li></ul><ul><li>Research Report Composition </li></ul><ul><li>Macro-Economic Analysis </li></ul><ul><li>Valuation Methodology </li></ul><ul><ul><li>DCF Valuation </li></ul></ul><ul><ul><li>Comparables Method </li></ul></ul><ul><ul><li>Precedent Transactions </li></ul></ul><ul><li>Investment Styles </li></ul><ul><li>Appendix </li></ul>Stock Analyst Program 2008
    3. 3. MIC Portfolio
    4. 4. <ul><li>In the last 12 months our portfolio has fared better than the S&P TSX Composite Index by 10.61% and has lagged the DJIA by less than a percentage point </li></ul><ul><ul><li>- Current holdings include MRK, CAT, XIU, BNI </li></ul></ul>Portfolio Overview Performance Summary Asset Mix Stock Analyst Program 2008
    5. 5. Research Report Overview
    6. 6. Equity Analysis Techniques Top Down Analysis Bottom Up Analysis <ul><li>Investor starts analysis with global economics by observing economic indicators </li></ul><ul><ul><li>-GDP growth, Inflation, Interest Rates, Exchange Rates, Productivity and commodity prices </li></ul></ul><ul><li>Investor narrows search down to industry analysis </li></ul><ul><ul><li>- In this case sales, price levels, cyclical patterns, local/foreign competition, rates of return and earning per share </li></ul></ul><ul><li>Company analysis involves the use of valuation techniques </li></ul><ul><ul><li>- DCF, Industry Comparables and precedents are used to value the company </li></ul></ul><ul><li>Investors analyze individual companies </li></ul><ul><ul><li>Emphasis is on company specific or industry specific ratios </li></ul></ul><ul><ul><li>Undervalued stocks can be labelled as a strong buy regardless of general macro-trends </li></ul></ul><ul><li>Essentially putting together “story of company and its numbers” </li></ul><ul><ul><li>The story component is composed of company’s business plan, outlook and other qualitative aspects </li></ul></ul><ul><ul><li>The quantitative part involves a thorough look at company financials </li></ul></ul>Stock Analyst Program 2008
    7. 7. Research Report Composition <ul><li>The key to writing a coherent SAP research report is understanding and articulating an investment time horizon </li></ul><ul><ul><li>- Refer to previous reports on the MIC website: Resources > SAP References </li></ul></ul>Stock Analyst Program 2008
    8. 8. Evaluation Criteria (1) <ul><li>Choice of industry articulated relative to other industries that would be affected by the general economy in a similar way. For example, the drug delivery industry and the drug manufacturing industry are affected by the same external economic conditions; thus it should be clear as to why one versus the other. </li></ul><ul><li>This would include use of ratios specific to industry, dcf valuation, comps, precedents, etc... This would also include quantifiable identification of relevant catalysts and earnings growth potential specific to the company. </li></ul>Research Report Evaluation Stock Analyst Program 2008
    9. 9. Macro-Economic Analysis
    10. 10. Macro-Economic Analysis (1) <ul><li>Cyclical indicators are a useful tool for anticipating market movements as they help to predict economic activity </li></ul><ul><ul><li>- Indicators are usually released monthly in the form of index numbers, quantities, or value </li></ul></ul>Cycle Significance and Composition The Indicators <ul><li>Cycles can be captured through four phases </li></ul><ul><ul><li>Expansion, peak, recession, trough </li></ul></ul><ul><li>These phases all vary in nature and duration as they are met under dissimilar circumstances </li></ul><ul><ul><li>- Policy intervention measures and business responses may differ across the same phases </li></ul></ul><ul><li>There are several indicators that can help us detect and measure the current and subsequent cycles </li></ul><ul><li>- Leading, lagging, coincident </li></ul><ul><li>Sourced to “Guide to Economic Indicators”, The Economist. </li></ul><ul><li>Interest rates may also appear in many cases as a lagging indicator, if policy measures taken are reactionary rather than anticipatory. </li></ul><ul><li>Time span (either maximum or minimum) by which the economic indicator usually reverses in trend in terms of total output. </li></ul>Stock Analyst Program 2008
    11. 11. Macro-Economic Analysis cont’d. <ul><li>An alternative approach to using economic indicators is to use them as directional devices in terms of specific industries in light of their broader macro-economic implications </li></ul>Alternative Measures (1) <ul><li>Sourced to “Guide to Economic Indicators”, the Economist. </li></ul><ul><li>The producer price index may overstate cost pressures when above average discounts are offered during a recession, or understate cost pressures when inflation is rapid.ly increasing </li></ul>Stock Analyst Program 2008
    12. 12. <ul><li>Sourced to Wall Street Journal’s market data center. </li></ul>Economic Calendar Stock Analyst Program 2008
    13. 13. Stock Valuation Methodology
    14. 14. <ul><li>Valuation methodologies are not mutually exclusive and in fact are more effective when used to validate one another </li></ul><ul><ul><li>Sector coverage is important in determining which methodology to use and what to take into account </li></ul></ul>Overview Stock Analyst Program 2008
    15. 15. Valuation Methodology <ul><li>Determine the stream of revenue being generated </li></ul><ul><li>Derive weighted average cost of capital (WACC) for firm or </li></ul><ul><li>rate of return specific to asset </li></ul><ul><li>Risk cash flows according to WACC </li></ul><ul><ul><li>Assumes time value of money </li></ul></ul><ul><ul><li>General assumptions on terminal value are used </li></ul></ul>Discounted Cash Flow (DCF) Precedent Transactions <ul><li>Determine from past transactions similarities i.e. industry composition, level of risk, size of the transaction </li></ul><ul><li>Filtering through the assumptions being used for the precedent transaction allows transparency in your own valuation </li></ul><ul><li>The more transactions the better </li></ul><ul><ul><ul><li>-Relevant private transactions may or may not be available for use </li></ul></ul></ul><ul><li>Develop case studies for the most relevant transactions to determine an appropriate range to use </li></ul><ul><ul><li>- Put more weight on transactions with similar assumptions </li></ul></ul><ul><li>Determine the relevant industry classification </li></ul><ul><ul><li>Use of industry based ratios </li></ul></ul><ul><ul><li>If specific industry does not exist, work backwards </li></ul></ul><ul><li>Relative comparisons are key; company vs. company & company vs. industry average </li></ul><ul><li>Gives a brief idea of where company lies and who key competitors are </li></ul><ul><ul><li>- Allows us to determine best/worst of breed </li></ul></ul>Comparable Transactions Stock Analyst Program 2008
    16. 16. DCF- Methodology <ul><li>First determine WACC = D/V * R d (1-T) + E/V * R e </li></ul><ul><ul><ul><li>- Use target (optimal) D/E ratio </li></ul></ul></ul><ul><ul><ul><li>- Beta  CAPM </li></ul></ul></ul><ul><ul><ul><li>- R d (1-T)  discuss importance of tax shield </li></ul></ul></ul><ul><li>Mechanics of FCFF </li></ul><ul><ul><li>FCFF = EBIT(1-T) – CAPEX + NCC +- Δ NWC </li></ul></ul><ul><ul><ul><li>- Explain that CAPEX and NWC are all cash sources/uses that don’t </li></ul></ul></ul><ul><ul><ul><li>affect EBIT, therefore we must adjust. </li></ul></ul></ul><ul><li>Analyze historical performance to come up with future set of assumptions </li></ul><ul><ul><li>(COGS, SG&A, R&D, “DEP”, “CAPEX”, “NWC” as a % sales) </li></ul></ul><ul><ul><li>- Therefore, we need to use revenue as a driver, and determine its growth </li></ul></ul><ul><ul><li>from year to year during our explicit forecast period (5-10 yrs) </li></ul></ul>Discounted Cash Flow Method Stock Analyst Program 2008
    17. 17. DCF- Methodology <ul><li>Determine FCFF’s each year using assumptions driven off of revenue </li></ul><ul><li>Determine TV at last year of forecast period </li></ul><ul><ul><ul><ul><li>1) Growing perpetuity </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>- Assumes constant growth rate (2-3%) – not really used </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><li>2) Terminal multiple </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>- Assumes an exit multiple of an operating metric like EBITDA or FCFF, to determine a value for the enterprise at that point in time </li></ul></ul></ul></ul></ul><ul><li>Bring everything back to present value at WACC </li></ul><ul><li>Now we have the value of the enterprise (Enterprise Value = Net Debt + Equity + Minority Interest) </li></ul>Discounted Cash Flow Method Stock Analyst Program 2008
    18. 18. Precedent Transactions, Basic Steps <ul><li>1. Find historical take-overs in industry </li></ul><ul><ul><li>Again, look for similar size if possible, and most recent first </li></ul></ul><ul><li>2. Try to cover at least on economic cycle in terms of precedent transactions, as some take-over premiums might reflect a take-over boom in an industry </li></ul><ul><li>3. Multiply relevant multiple (P/E, EV/EBITDA, EV/Sales, etc.) by company’s figure to obtain firm’s value in event of a take-over </li></ul>Precedent Transactions Method Stock Analyst Program 2008
    19. 19. Relative Valuation, Basic Steps <ul><li>1. Determine the target company’s EPS, EBITDA, or Sales for current year and possibly forward year (using analyst estimates) </li></ul><ul><ul><li>- Always use recurring income </li></ul></ul><ul><li>2. Determine the set of comparable companies (comp universe) and their trading multiples (based on recurring figures!) </li></ul><ul><ul><li>Similar companies based on industry, size, business model, risk, capital structure – anything you can control for </li></ul></ul><ul><li>3. Multiply average industry multiple by current or forward performance to determine the relative value of the firm </li></ul>Relative Method Stock Analyst Program 2008
    20. 20. Investment Styles
    21. 21. Summary <ul><li>Based on the stock’s intrinsic value </li></ul><ul><ul><li>- Low PE, P/BV, P/CF multiples </li></ul></ul><ul><ul><li>- Long term time horizon </li></ul></ul>Value Investing Growth Investing Contrarian Investing GARP Investing <ul><li>Personal risk preference, time horizon, and skill set determine the best investment </li></ul><ul><li>style to employ </li></ul><ul><li>Seeking future growth potential and earnings strength </li></ul><ul><li>A hybrid combination of growth and value strategies </li></ul><ul><ul><li>Brought to main stream use by Peter </li></ul></ul><ul><ul><li>Lynch </li></ul></ul><ul><ul><li>- Emphasis on the PEG ratio </li></ul></ul><ul><li>Goes against conventional market wisdom </li></ul><ul><ul><li>- Crowd behaviour creates mispricings </li></ul></ul>Stock Analyst Program 2008
    22. 22. Value Investing: A Closer look <ul><li>Both Graham and Buffet are fundamental value investors who use long term strategies to benefit from relatively cheap companies </li></ul>1. Sourced to John Reese, Todd Glassman; “Market Gurus.” Time Horizon Risk Level Effort Stock Analyst Program 2008
    23. 23. Ratios and Techniques; Value Investing Benjamin Graham Warren Buffet 1. Sourced to John Reese, Todd Glassman; “Market Gurus.” Stock Analyst Program 2008
    24. 24. Buffett’s Due Diligence First Stage Analysis <ul><li>Take a look at the nature of the company’s business </li></ul><ul><ul><li>A viable company will have the size, depth, and breadth of brand recognition </li></ul></ul><ul><li>Inflation sustainability and ability to pass on costs </li></ul><ul><ul><li>Look for ability to increase cost of main product relative to inflation </li></ul></ul><ul><li>Products are understandable and business lines are comprehendible </li></ul><ul><li>Company is able to have predictability in terms of earnings </li></ul><ul><ul><li>Earnings growth or expansion is also a requirement </li></ul></ul><ul><ul><li>A short dip in earnings growth is acceptable given certain circumstances </li></ul></ul><ul><li>Consideration given to companies with conservative finances </li></ul><ul><ul><li>This includes low levels of debt relative to net income </li></ul></ul><ul><li>Close scrutiny towards managements use of retained earnings towards shareholder wealth </li></ul><ul><ul><li>ROE over the past 10 years should be greater than 15% on average </li></ul></ul><ul><li>High free cash flow and low capital expenditures </li></ul><ul><ul><li>- Capital expenditures should not be excessive </li></ul></ul>1. Sourced to John Reese, Todd Glassman; “Market Gurus.” Stock Analyst Program 2008
    25. 25. Second Stage Analysis <ul><li>Determine if the company is priced appropriately </li></ul><ul><ul><li>Step 1 . Calculate IRR </li></ul></ul><ul><ul><li>- Determine through EPS/Market Price </li></ul></ul><ul><ul><li>Step 2. Compare calculation made in step 1 to the long term bond yield </li></ul></ul><ul><ul><li>- Exceptions can be made if company’s expected yield growth is high </li></ul></ul><ul><ul><li>Step 3 . Calculate Future EPS: First calculate 10 year average ROE from balance sheet figures, then calculate average dividend payout ratio in order to find the average retained earnings </li></ul></ul><ul><ul><li>- Since % ROE retained = (Avg ROE/ 100) ×(1- (Avg payout/100), </li></ul></ul><ul><ul><li>- Multiply ROE retained by 100 and use as interest rate to solve for FV (equity per share) given PV as current equity per share </li></ul></ul><ul><ul><li>- Take FV (equity per share) multiply by 10 year average ROE to get future EPS </li></ul></ul><ul><ul><li>Step 4 . Use the above future EPS and multiply by average PE (last 10 years) to get projected future stock price </li></ul></ul><ul><ul><li>- Include dividend pool to stock price by taking company’s estimated EPS for current year adjusted for growth rate in dividends to give you a projected EPS </li></ul></ul>Buffett’s Due Diligence cont’d 1. Sourced to John Reese, Todd Glassman; “Market Gurus.” Stock Analyst Program 2008
    26. 26. Second Stage Analysis Buffett’s Due Diligence cont’d <ul><ul><li>Step 4 cont’d . </li></ul></ul><ul><ul><li>- Use the projected EPS in each year, multiply by (average dividend payout/100) . </li></ul></ul><ul><ul><li>- Use the sum of the above value and add back to the stock price calculated above </li></ul></ul><ul><ul><li>Step 5. Use the above calculations to determine expected return using the ROE method </li></ul></ul><ul><ul><li>PV- Current Stock </li></ul></ul><ul><ul><li>FV- Future stock price adjusted for dividends from step 4. </li></ul></ul><ul><ul><li>N- number of periods (in this case 10) </li></ul></ul><ul><ul><li>i- Solve </li></ul></ul><ul><ul><li>Refer to ratio criteria to determine expected return threshold </li></ul></ul><ul><ul><li>Step 6. Determine the expected return using the EPS growth (average) </li></ul></ul><ul><ul><li>- First take the average EPS growth for last 10 years </li></ul></ul><ul><ul><li>- Project the 10 year EPS figure by using this growth rate and current EPS </li></ul></ul><ul><ul><li>- Determine Future stock price by multiplying by 10 year PE (average) </li></ul></ul><ul><ul><li>Step 7. Calculate expected return as per step 5, using the EPS growth method </li></ul></ul><ul><ul><li>Step 8. Compare the results using the average of the expected returns from both the ROE and EPS method </li></ul></ul>1. Sourced to John Reese, Todd Glassman; “Market Gurus.” Stock Analyst Program 2008
    27. 27. Growth Investing Time Horizon Risk Level Effort <ul><li>“ Buy High, Sell even Higher!”, according to O’Neil the best of breed companies are supposed to be expensive </li></ul><ul><ul><li>- His strategy involves continuously monitoring your investments </li></ul></ul>1. Sourced to John Reese, Todd Glassman; “Market Gurus.” Stock Analyst Program 2008
    28. 28. Growth Investing cont’d William O’Neal <ul><li>In addition to his “growth metrics” O’Neal also looks for potential catalysts within the company’s industry or within the company as a driver for growth </li></ul>1. Sourced to John Reese, Todd Glassman; “Market Gurus.” Stock Analyst Program 2008
    29. 29. Value versus Growth 1. Sourced to Bloomberg Financial. Both Value and Growth index are from BARRA. Relative Price Performance <ul><li>Until recently the Value Index has outperformed the Growth Index </li></ul>Stock Analyst Program 2008
    30. 30. Value versus Growth Time Horizon Risk Level Effort <ul><li>Lynch combines growth and value strategies in his investment thesis </li></ul><ul><ul><li>Emphasize on what you already know </li></ul></ul><ul><ul><li>Known for PEG ratio: determines if stock is fairly priced relative to growth </li></ul></ul>1. Sourced to John Reese, Todd Glassman; “Market Gurus.” Stock Analyst Program 2008
    31. 31. Against Conventional Wisdom Time Horizon Risk Level Effort <ul><li>Dreman goes after out of favour companies whose stock have taken a serious beating </li></ul>1. Sourced to John Reese, Todd Glassman; “Market Gurus.” Stock Analyst Program 2008
    32. 32. Against Conventional Wisdom cont’d David Dreman 1. Sourced to John Reese, Todd Glassman; “Market Gurus.” Stock Analyst Program 2008
    33. 33. Appendix
    34. 34. Important Ratios Activity Ratios Liquidity Ratios 1. Sourced to CFA institute, Financial Statement Analysis. Stock Analyst Program 2008
    35. 35. Important Ratios Solvency Ratios Profitability Ratios 1. Sourced to CFA institute, Financial Statement Analysis. Stock Analyst Program 2008
    36. 36. Important Ratios Performance Ratios Coverage Ratios 1. Sourced to CFA institute, Financial Statement Analysis. Stock Analyst Program 2008
    37. 37. Resources Stock Analyst Program 2008

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