Fundamental Equity Analysis

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

2. Humor & Caution: DLJ’s 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 STREET’s 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 S&P 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 STOCKPICKER’S 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 (don’t minimize) • Learn from Professor • TURN MISTAKES INTO LEARNING My Goal / Deliverable: Students can prepare a professional securities analysis by end of session Destination is > Interim Progress

8. 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 My Finance Philosophy

9. Traditional MBA Do some ratios Quick Answers This Class Sleuthing Thought & Logic Analytical Models Two Approaches to Research 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 • Can’t be Taught, BUT it can be offset by other factors • Buffet is rumored to be a genius • Geniuses can see what others don’t • 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. Don’t 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 • DON’T 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) • Don’t worry: you’ll 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)