Desai Capital Management provides a summary of key factors they consider when conducting value screening to identify attractive investment opportunities. They look for companies with market caps over $3 billion that are in established industries with predictable competitive landscapes. Relative valuation metrics are analyzed against industry and historical averages to identify undervalued companies. Insider purchasing is viewed favorably as a sign that management sees upside. Activist investor campaigns can also bring attention to undervalued situations. Restatements, management turnover, and large unfunded pension liabilities are red flags.

1. DESAI CAPITAL MANAGEMENT, LLC
AN SEC/FINRA REGISTERED INVESTMENT ADVISOR
Contact: Ashish S. Desai, CFA ADesai@desai-capital.com 646.373.8145
Date
Date: February 24, 2016
From: Ashish Desai; A.J. Noronha
To: Investors, Family, Friends
Re: Value Screening – Finding Value in an Uncertain Market
Dear Investors, family, and friends:
As a longtime value investor, I have noticed that there is frequently many useful tools that help me identify truly attractive value
investing opportunities. Experience is often the best teacher, and through close review of both my winning and losing
investments over the years I have identified several factors which continue to play a valuable role in our investment approach
and which I believe can help other investors. I hope you find this helpful, please feel free to pass this along to others in your
network whom may find it of interest, and as always please let me know if you have any questions or would like to discuss
anything further.
Market Cap: As a general rule, we start considering companies with a market cap over $3 Billion. We prefer companies with a
market cap over $10 billion, as their greater resources provide them with a greater ability to withstand one-time events. Also,
value companies that can create economies of scale in an established industry are often attractive.
That said, these are meant to be guidelines rather than hard rules, and we may include exceptions that still offer value after
undertaking the same rigorous screening process we apply to all potential investments. As one example, large-cap companies
that have tumbled below $3 Billion (often considered “fallen angels”) but still have strong brand names and a large asset base
should be considered, especially when this change is cyclical or due to market inefficiency rather than a large change in its
fundamental drivers of value. Airlines that have gone under bankruptcy protection are a great example, as bankruptcy often
allows the new entity to emerge with stronger cost controls while maintaining its brand name, and we have previously had
successful investments with airlines such as AAL. Also, ADRs of companies that are large-caps and may have a market cap over
$3B on their home exchange but have a smaller float in the U.S. often provide an attractive opportunity to buy established blue-
chip companies while benefiting from market inefficiency. Companies that have OTC ADRs with a small market cap in the US but
large cap in their home market include Samsung, BNP Paribas, and Gazprom.
Industry: We maintain a flexible focus and are willing to consider investments across a broad range of industries, but industries
with at least ten years in existence are preferable. The longer the industry has existed, the more predictable the competitive
landscape is, and this also makes it easier to understand our target company’s relative position within the broader industry. Also,
we prefer industries with clear trends rather than uncertain ones, as this makes it easier to judge if the industry is obsolete or

2. contracting (e.g. newspapers, personal computers). If an industry is relatively new, it is hard to see how large the opportunity is
and how much competition is expected. As a value investor, it becomes difficult to forecast future revenues and earnings with no
approximation of competitors in the market. Internet search in the dot-com boom and social networking in the last five years
would be examples of new industries that have constantly changing markets – again, these may be good investment
opportunities and great fits for growth investors, but are harder to evaluate from a value investing framework.
Relative Valuation: Value companies tend to have relative value ratios that are lower than a) the industry b) its’ own average
over five years c) if relevant, of a benchmark index (e.g. S&P 500, S&P Transports). We commonly use metrics such as trailing P/E,
forward P/E, P/B, and Enterprise Value/EBITDA to give us an indication of the relative value in comparison to a stock of its peers
or the greater market (e.g. S&P 500). The first mistake we make is using the wrong metric. P/B is relevant when you are speaking
of financial services companies, REITs, companies with large amounts of regularly measured assets. Book value measurements
also allow for large deviations regarding intangible and asset write-downs, making these areas to watch for possible earnings
misrepresentation.
P/E can be a valuable comparison metric when it comes to companies with very similar capital structures. Companies very
frequently can have low P/Es when they choose to finance heavily with debt. Take the airline industry during the financial crisis.
Delta, United, US Airways, American, and Northwest all declared bankruptcy while sporting low P/Es that were the result of high
levels of debt. While they might appear to be a bargain at a superficial glance, a deeper look would show that they essentially
become substantially more risky and expensive when you factor in bankruptcy risk. Southwest, which had a higher P/E, was more
conservative with its use of debt and thus did not require bankruptcy protection. For companies with high or significantly
differing debt burdens, Enterprise Value can be substituted for Price to come up with a more accurate comparison for returns on
capital.
Furthermore, enterprise value/EBITDA takes into account all capital sources but requires greater inspection of debt structure, tax
treatments (deferrals, loss carryforwards, international operations) and various methods of depreciation. In order to accurately
compare using this metric, adjustments would have to be made. In the case of GE, they pay a much lower tax rate than the 35%
US corporate rate, have many international subsidiaries and have significant depreciation of industrial plant and equipment. To
compare them to another industrial company of a similar scope would be costly and time-consuming. However, a consistently
profitable company with operations that are predominantly in the same country can be used as a reasonable comparison.
Trailing and forward P/E have limitations. Obviously trailing P/E is easier to measure. Comparing forward P/E ratios implies that
there is equal faith in the forecasting of both companies’ results. However, investors have more interest in the future of the
company. A heavily followed company will have an average consensus forecast. This can be a useful tool in comparisons of
companies of similar size, scope, industry and capital structures.

3. Insider purchases/sales: Insider activity should give a solid indication of the direction of the company. These are the people that
have the best knowledge of the company, and their willingness to invest their personal capital or not can show how they truly
feel about the company regardless of their public statements (“putting their money where their mouth is”). The amount of the
transaction is not always the most important aspect, but the number of insiders gives a greater insight. If one insider buys a large
amount of the stock, that might be an indication of future prospects or merely an irrational attachment of a founder to his/her
company. However, If several insiders take a similar action, that increases the likelihood that there is a consensus amongst them
about the future prospects of the company. Dell and RJR Nabisco include instances where insiders were buying not only because
they believed in the future of the company but they also were amongst groups trying to acquire the company. The shareholders
were well rewarded.
Exceptions to this include post-IPO selling because this may just be a diversification of their overall financial assets. Also, post-
merger selling by insiders leaving the company is not considered unusual considering many will be leaving the company.
Activist investors: Activist campaigns are typically done with significantly undervalued companies that have strategic options
available to them. Activist investors believe that the company’s assets are not utilized in a way that maximizes shareholder value.
Usually, the activist investor has a detailed plan before taking a position. Multiple activist investors cause a bidding war or
combine their efforts to exact a change. Both are usually positives for the stock. Also, these tend to be stocks that have gone
under the radar for a long period. This is a way to bring attention and possibly a catalyst at the same time. Furthermore, there is
an investor that will keep buying on most pullbacks until they decide their final action. For example, Carl Icahn recently had a
very successful activist campaign at Apple which did not require any significant changes in its fundamental business but rather a
reallocation of their liquid assets. The stock went from $400 to $700 (prior to a stock split) following this reallocation, and has
since hit an all-time high. Pershing Square also made a large profit on a cost reduction campaign with Proctor and Gamble in
2013.
Restatements: Companies that restate earnings or frequently revise forecasts have typically mismanaged audit/accounting
systems and/or possible misrepresentation of earnings. A company cannot be considered a value company if there is no faith in
the financial data given by the company. As an example, Brazil’s Petrobras had a substantial delay in releasing its fully audited
earnings results in late 2014 in the midst of a corruption scandal, leading to a strong adverse market reaction. Hertz tumble has
also been associated with restatements and delays.
Management turnover: Significant management turnover, especially in a short amount of time, signals instability for a company.
Value companies tend to have undervalued managements. A mismanaged company that keeps to a succession plan is not
necessarily a good thing. The CEO may change but the plan that has reduced value stays in place. This is not the sign that things
are about to reverse course, as any changes will likely be superficial and not serve as a value driver. In contrast, companies that

4. replace underwhelming management with management that can clearly articulate a strong value can often provide the value
investor with a great opportunity. Satya Nadella taking over for Steve Ballmer at Microsoft showed a new vision, a reason to
believe that things would change and the markets took notice. Also, abrupt departures of high level executives, specifically CFOs
can signal possible accounting and financial mismanagement that could set the company back for several years or even worse.
That means that any unlocked value is not likely to be realized for some time. Also, it may hinder would be acquirers. For
example, Lehman Brothers saw both its President/COO and CFO depart shortly after a disappointing earnings release, and ended
up filing for bankruptcy potential within the year
Pensions: If the financial statements show a large portion of pensions are unfunded, that indicates an aggressive accounting
standard. The assumptions for pension funding have been too optimistic. This will affect cash flow negatively going forward. Also,
this aggressive accounting may spread to other areas such as revenue recognition and depreciation. This is a factor that makes it
more difficult to discern if the company is truly undervalued. Steel companies -notably US Steel- make large moves when they
release their pension returns. Even changes in assumptions can trigger large moves. Other industries which are largely affected
would be airlines and auto which have large union memberships. This is a factor that greatly affects municipal bonds.
Regards,
Ashish S. Desai, CFA
A.J. Noronha