Welcome to Finance and Accounting

1. Welcome to Finance and Accounting Abhijan Khosla (Director of Mentorship)

2. Debt vs. Equity • Debt is a loan • If things go south you get first rights to what’s left in the company (usually hard assets) • Equity is ownership • There is only a fixed amount of equity in a company • You can make more but the existing owners shares are worth less • As an owner you have rights to the company’s profits (EPS/Dividends) • When things go south you go last GTSF Investments Committee

3. Quiz Time! Who is the father of value investing? • Alexander Graham Bell • Benjamin Graham • Warren Buffett • Ben Bernanke GTSF Investments Committee

4. Quiz Time! Who is the father of value investing? • Alexander Graham Bell • Benjamin Graham • Warren Buffett • Ben Bernanke GTSF Investments Committee

5. Quiz Time! You shorted AAPL at $750 and covered at $250 (assuming $10 in fees) how much do you make on this trade? • 200 • 490 • -200 • -190 GTSF Investments Committee

6. Quiz Time! You shorted AAPL at $750 and covered at $250 (assuming $10 in fees) how much do you make on this trade? • 200 • 490 • -200 • -190 GTSF Investments Committee

7. Quiz Time! Which is not true of an OTC Market? • The prices are not listed in any central location • Buyers assume all the risk • Market makers help to determine prices • Fixed income is an example of an OTC security GTSF Investments Committee

8. Quiz Time! Which is not true of an OTC Market? • The prices are not listed in any central location • Buyers assume all the risk • Market makers help to determine prices • Fixed income is an example of an OTC security GTSF Investments Committee

9. Who Am I? GTSF Investments Committee

10. The 1 thing you need to knowA dollar today is worth MORE than a dollar tomorrowToday > Tomorrow GTSF Investments Committee

11. Time Value of Money • Interest has an impact on the value of an investment • If compound interest is used then the growth of an investment in different time periods reflects all previous interest earned • If I earned 10% a day on $100 how much would I have tomorrow? • In 4 days? • In 10 days? GTSF Investments Committee

12. Time Value of Money • Use a timeline to visualize cash flows • Future Value - Value at a time in the future • Present Value - Value in “todays dollars” • Which one should be greater? • Formula; FV = PV (1 + I/Y)^N • FV = future value • PV = present value • I/Y = interest rate per period • N = number of periods GTSF Investments Committee

13. A few practice problems • Bill earns a 4% annual return on his HLF short, if he invested $1,000 exactly 3 years ago how much does he have today? • Ben needs $50,000 by 2020, if he started investing in 2014 and earned a 5% annual return how much does he need to invest? • Geoff began investing in 2010. He invested $100 and earned a 2.5% quarterly return. How much does he have today? How much will he have in 5 years? GTSF Investments Committee

14. But.....Why? • As in investor you must be compensated for giving up your money • Compensation depends on risk • What are some main risks? • Counterparty (Default) Risk • Reinvestment Risk • Maturity or Duration Risk GTSF Investments Committee

15. The 3 Financial Statements • What are the 3 Financial Statements? • Income Statement • Statement Of Cash Flows • Balance Sheet GTSF Investments Committee

16. Balance Sheet • Called a snapshot in time • Reflects the company’s assets, liabilities and shareholder equity at the time (quarterly or annually) • Listed in order of Liquidity Assets = Liabilities + Shareholder Equity GTSF Investments Committee

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18. GTSF Investments Committee

19. Income Statement • Major Line items of an Income Statement; Revenues - Cost of Goods Sold Gross Margin - Operating Expenses Operating Income - Other Expenses -Income Taxes Net Income GTSF Investments Committee

20. Income Statement GTSF Investments Committee

21. Statement Of Cash Flows(CF) • 3 Components of the Statement of CF Cash from Operations Cash from Investing Cash from Financing • Beginning Cash + CF from Ops+ CF from Investing + CF from Financing = End Cash GTSF Investments Committee

22. Statement Of Cash Flows(CF) • Cash from Operations • Cash generated from the normal operations of the company • Cash from Investing • Change in cash from activities outside normal scope of business • May include the purchase of property, plant and equipment, and other investments not on the income statement • Cash from Financing • Cash from the issuance or repurchase/repayment of equity and debt GTSF Investments Committee

23. The 3 Musketeers • The 3 statements work together; Cash flow from Operations (Statement of CF) Net income (Income Statement) Cash from previous Balance Sheet (Balance Sheet) Beginning Cash Balance (Statement of CF) Ending Cash Balance (Statement of CF) Cash on Balance Sheet (Balance Sheet) GTSF Investments Committee

24. Company Reporting • Any publicly traded US company is required to report comprehensive financials • Quarterly reports - 10Q • Annual Reports - 10K • Foreign companies with stock trading in the US must also file annual and quarterly financial reports • sec.gov • Footnotes –can often house interesting information about the company that must be disclosed but is not part of the 3 financial statements GTSF Investments Committee

25. Valuation • What is valuation? • Who uses valuation? • What are some of the most common metrics used when valuing a company? • What are some of the different ways to value a company? GTSF Investments Committee

26. Valuation Basics • Valuation is the procedure of calculating the worth of an asset, security, company, etc... • Valuation is one of the primary tasks done by investment banks • Being good at providing valuations for companies is an invaluable skill set used in all facets of finance • There are 4 main ways to value companies • Comparable Companies • Precedent Transaction • Discounted Cash Flow Modeling • Leverage Buyout Modeling GTSF Investments Committee

27. Commonly Used Metrics • One way to value a company is to compare it to its peers (Comparable Multiples Method) • There are a multitude of multiples used • The most common are • Enterprise Value (EV) /EBITDA • Price/ Book Value • Price/Earnings • PEG • EV/Sales • Price/Sales GTSF Investments Committee

28. Enterprise Value (EV) • EV- Enterprise Value • Value of the entire firm including both debt and equity • EV = Market Value of Equity + Debt + Preferred Stock + Minority Interest - Cash • Why take out cash? • Cash is already counted in market value in equity (in theory) • You can use cash to pay down debt or pay a dividend - you would not buy a company for its cash GTSF Investments Committee

29. EBITDA • EBITDA - earnings before interest, taxes, depreciation and amortization • Good way to evaluate a company’s profitability • EBITDA = Revenues - Expenses (excluding taxes, interest, depreciation and amortization) • Represents the earnings that can effectively service debt, rose to prominence during the leverage buyout boom of the 80’s GTSF Investments Committee

30. Income Statement GTSF Investments Committee

31. Free Cash Flow (FCF) • Simply the amount of free cash a company has • Formula: • EBIT (1-tax rate)+Depreciation & Amortization - Change in Net Working Capital - Capital Expenditures • NWC = current assets - current liabilities • Why do we use 1-tax rate? • Why subtract Change in NWC and Capital Expenditures? GTSF Investments Committee

32. EV/EBITDA • Essentially “at what multiple of earnings is the entire company valued at” • EV/EBITDA is the most common metric used when doing comparable multiple analysis • Varies greatly with industry • If the industry average EV/EBITDA multiple is 6X and your company has an EBITDA of $100MM what is your company’s EV? GTSF Investments Committee

33. Price/Book • The current share price / book value of the firm • Book value = total assets - intangible assets - liabilities • Book value is the theoretical value of assets that would be recovered in the event of a total firm liquidation • Assume ; • Total assets; 10MM • Intangible assets; 1MM • Liabilities; 6MM • Market Value; 21 MM • Price/Book? GTSF Investments Committee

34. Price/Earnings (P/E) • The PE ratio of a firm is the multiple at which the stock price is trading as compared to earnings per share (EPS) • P/E - Current stock price / EPS • Stock Price - 502.20 • EPS - 40.44 • P/E - ? • What do you do if you have negative EPS? GTSF Investments Committee

35. PEG • The PEG ratio of a firm is the Price/Earnings to Growth ratio • P/E ratio divided by the growth of the earnings over a specified period of time • Can be in the past or the future (trailing vs forward) • PEG takes into account the growth of earnings and helps to give a more complete picture of relative price • If our firm’s P/E was 40 and our annual EPS growth rate was 20% what is our PEG? • For what kind of firms would PEG be a good metric? GTSF Investments Committee

36. Price and EV/Sales • Price/Sales • Current Market Cap / Sales • EV/Sales • Enterprise Value/Sales • If AAPL generated $32MM in sales has a market cap of $640MM , debt of $17MM and cash on hand of $20MM what are the price/sales and EV/sales ratios? • Name 2 companies for which Price/Sales is a good metric and 2 for which it is bad GTSF Investments Committee

37. DCF and LBO • DCF - discounted cash flow model • A common modeling method which uses free cash flow (similar to EBITDA) to drive the valuation of the firm • We project out FCF, decided on terminal growth rates and discount the cash flows back to present day • LBO - leverage buyout model • Used primarily by PE firms when valuing companies they may be interested in acquiring • Centered around the use of enormous amounts of debt which will be paid off to increase the PE firms relative ownership stake GTSF Investments Committee

38. Other Ratios • Valuation ratios are used to determine how a stock is valued in the marketplace • All the metrics described depend on the current price of the stock or the current market capitalization of the company • These ratios are often swayed by market dynamics which are not always accurate • Efficiency ratios help us to simply look at the effectiveness of the company without the market’s interference GTSF Investments Committee

39. Efficiency Ratios • Allow investors to see how effectively a firm is using its resources • The most common are; • Operating Margin • Profit Margin • Return on Equity • Return on Assets • Return on Invested Capital GTSF Investments Committee

40. Operating and Profit Margin • Allow investors to see what percentage of each dollar made translates to the company’s bottom line • Operating Margin • EBIT/Sales • gives an idea of how well management has been at generating income from the operation of the business • EBIT includes all revenues, not just sales • Profit Margin • % of sales that flows directly to profit • Net income/Sales GTSF Investments Committee

41. Income Statement GTSF Investments Committee

42. Return on Equity and Assets • Return on equity represents the amount of profit generated on each dollar of equity funding in the company • Net Income/ Shareholders Equity • Return on Capital represents the amount of profit generated on each dollar of assets held by the company • Net Income/Total Assets • Helps to measure how good management is at using assets on hand GTSF Investments Committee

43. Return on Invested Capital • Return on invested capital is a measure of how well capital is being used to generate profits, essentially with all the funding being given to the company how much are they using to make money? • Net income - Dividends / Total Capital • Use the balance sheet and income statements on the next slides to calculate Return on Equity, Assets and Invested Capital GTSF Investments Committee

44. Income Statement GTSF Investments Committee

45. GTSF Investments Committee

46. Ratios in Perspective • Ratios help to clarify investing theses • It is important to use ratios and number to backup your thoughts about a company • There is no “magic ratio” • Learning which ratios work the best takes time and experience • The one thing you NEVER use to decide on an investment PRICE GTSF Investments Committee