Presentation Procedure

By: Phil Garrett

Overview

• Choosing a Company

• Evaluating a Company

• Presenting a Company

• Typical Mistakes

Choosing a Company• The Student Investment Association is a value fund

– Your pitch should be focused around why this company is undervalued• Look for companies that are trading with a low price/book ratio (P/B) and a low

price/earnings ratio (P/E) relative to their peers

• Choose a small- to mid-cap company– Market Capitalizations from $500 MM - $5 B

– Less analyst coverage

– The size effect

Choosing a Company• Benjamin Graham

– Investing with a Margin of Safety• Invest in a company whose stock price is trading at a significant discount to its

intrinsic value

• Look for unpopular or out-of-favor companies

– Mr. Market• AAPL 52 wk range: $196.89 - $364.90 Shares Outstanding: 921.28 MM

• $154.8 B

• A low P/E and P/B ratio does not ALWAYS mean the company is undervalued– Look for companies that have a high Return on Invested Capital

Evaluating a Company• Read through a company’s financial statements (10-K,10-Q)

and transcript from the earnings call

• Analyze the company’s industry− Porter’s 5 Forces

• Competition: who are their competitor, how competitive is the industry

• New Entrants: what are the barriers to entry, is it easy to enter the industry

• Substitutes: What are the substitutes, is it for consumers to substitute their product

• Power of Suppliers: Who are their suppliers, can they control the pricing

• Power of Buyers: Who are their buyers, can they control the pricing

− What are other factors that affect the industry• Government regulation

• Commodity prices

• Seasonality

Evaluating a Company• Assess the company’s strategy

– What is their competitive advantage• Low cost leaders, differentiation

– What is their plan for the future

– Is the company sustainable, why• What risk and success factors they must manage

• Analyze the company’s profitability and risk– Use financial ratios and compare them over time and against

competitors and the industry

– Use any industry specific measures • Same store sales, FFO, EBITDAR

Evaluating a Company• Analyzing a company’s profitability and risk cont’d

– Has the company’s margins increase, decreased or maintain

– What is the company’s ROA and ROE• Is the ROE greater than the cost of equity

– What does their short-term liquidity look like• Current/quick ratios, Days in Inventory, Days A/R outstanding, Days A/P

outstanding

– What does their long-term liquidity look like• Debt to Equity ratio, Interest Coverage ratio

– Compare these factors for the company over the past several year and currently against its competitors

Evaluating a Company• Forecasting future performance

– The information gather in prior steps

– Management guidance

– Use analyst reports to get ideas about how others think about the company.

• Don’t use them as your own work

• Valuation– SIA provides a sample Discounted Cash Flow model on the website

– Use that to input historical data and your forecasted projections to value the company

• Take a step back and think “does this make sense?”

Discounted Cash Flow• The value of any resource is the present value (PV) of the

future payouts discounted at a rate reflective of the risk of the payouts

• Then to value the company, we project the future free cash flows to equity and discount them to present value.

• It’s hard to project the free cash flows reliably after 5 years– Use the terminal value method to capture the present value of the free

cash flows into perpetuity

• Use the cost of equity as the discount rate because we are looking at the FCF to equity– The cost of equity is calculated using CAPM

Discounted Cash Flow• We project firm growth through revenue and the rest of the

components in the DCF model are percentages of revenue.

• The terminal value is a large part of the company’s value – be conservative with estimate– The long-term growth rate shouldn’t grow faster than GDP

• When using CAPM it is better to use historical averages rather current values.– Historical average risk-free rate: 6%

– Historical average market risk premium: 5.6%

• Be able to logically back each of your projections

Presenting a Company• Build your presentation around selling the 3 main reason, your

investment thesis, we should invest in this company

• Try to boil down the information to relevant facts surrounding your company

• Present both the 3 main reason and 3 biggest risks to the company

• Try to anticipate possible questions surround your investment and risks reasons and cover them in the presentation

Presenting a Company• Investment overview (1 slide)

– Have your recommendation and 3 main reasons to invest

• Company overview– Briefly cover how this company makes money

• Industry overview– Cover key industry information relevant to your investment thesis

• What is the issue surrounding the company– Why is the company trading at these low multiples

• Why is the company undervalued– Why is the market wrong

Presenting a Company• What is going to make you investment thesis come true

– Why should we invest in this company

• What are risks to your investment thesis– Why might the company no be undervalued

• Your valuation– Briefly walk us through your projections and your thought process

behind choosing these projections

Typical Mistakes• Presenting an overview of the company instead of focusing on

the relevant facts regarding why we should invest– Knowing who a company’s management is and what is the revenue

break down is important, but shouldn’t be presented unless it affects your investment thesis

• Making a decision about a company before evaluating it– Don’t base the facts around your decision, base your decision around

the facts.

– As you evaluate the company, if information doesn’t look like you expected then change your decision or company.

Typical Mistakes• Just because it’s in the news doesn’t mean it is relevant

– Unless the news story affects your investment thesis, it shouldn’t be included

• Not explaining what key terms are– If you weren’t comfortable using the term before you research the

company then it probably should be explained

• Forgetting about the efficient market hypothesis– The reason for buying or selling a stock shouldn’t be based on an event

– The reason should be based on the market’s under or over reaction to it

Questions?

Appendix

Ratios• Price to Earnings

– Current stock price / TTM EPS

• Price to Book– Current stock price / (Total Assets – Intangible assets – Liabilities)

• Return on Invested Capital– How well is the company using its money to generate returns

– (Net Income – Dividends) / Total Capital• Total Capital includes long-term debt, common and preferred shares,

additional paid-in capital

DCF Formulas

• Free Cash Flow to Equity– FCFE = NI + D/A – ΔNWC – Cap Ex

• FCFE = CF from Operations – Cap Ex

• Terminal Value– Terminal FCFE / (Cost of Equity – Growth Rate)

• CAPM– Cost of Equity = Risk-Free + Beta * Market Risk Premium