Strategic Capital Group Workshop # 3: Split-Second Trading

1. Strategic Capital Group Workshop #3: Split-Second Trading

2. Agenda Review of Multiples How A Market Works Earnings Reports and Surprises Company Size and Industry Flash Crash

3. Multiples Review • We touched on three multiples in the previous workshops: NAME THEM! • How are they calculated? P/E P/B P/S

4. Buy, sell or hold? The drink business is typically medium/slow growing, but consistent. When we see stocks undervalued in this kind of industry, it is typically a great time to buy. P/E = 15.81 P/B= 11.24 P/S = 5.43 Drink Industry P/E = 22.34 P/B= 15.62 P/S = 7.54

5. Buy, sell, or hold? The aerospace industry is slow growing and very stable, when we see stocks trading at higher multiples, they tend to be overvalued. P/E = 12.18 P/B= 14.70 P/S = 0.76 Aerospace Industry P/E = 8.75 P/B= 9.24 P/S = 0.65

6. Buy, sell, or hold? The technology industry is very fast growing and unpredictable, rendering relative valuation next to useless. We can only assume a high multiple represents expectations of future success. P/E = 967.21x P/B = 16.12x P/S = 17.51x P/E = 58.43x P/B = 8.34x P/S = 9.92x Tech Industry

7. So… • Low price multiples designate an undervalued company in industries that grow steadily, but not at huge rates • High price multiples represent a market’s expectations of future success in high growth industries like technology. • High price multiples in industries with low year-to-yeargrowth are indicative of a company that is overvalued.

8. Sanity Check Episode I • We just reviewed the three multiples taught in previous workshops • In most cases, a low multiple in an industry that has steady, consistent growth is a buy signal. Where as a high multiple in an industry with rapid growth doesn’t tell us much.

9. Why Do Stock Prices Move? • Supply and demand! • When there are more buyers of a stock thansellers, the sellers realize they can charge a higher price and get away with it, increasing the stock price • The same holds true for when there are more sellers than buyers, driving stock price down

10. What am I looking at? A stock’s price line is actually a series of data points that are plotted and connected. These data points each represent a single transaction of someone buying a stock another person is selling.

11. Check for understanding: • If a stock opened at $50.15 per share and there were no trades for the rest of the day, what is the stock price at the closing of the day? • If a stock opened at $50.15 per share and the only 3 trades were $51.42, $49.15, and $50.23, in that order, what is the stock price at the end of the day?

12. What Moves Stock Prices? 3 big factors that affect a stock’s price: Fundamental Is the company qualitatively strong? Technical Does the company make relatively strong revenues and profits? Overall Market Sentiment Does the market think this company will be strong/profitable in the future?

13. How does news affect a stock’s price? • Remember back to how stock prices move: Through the number of buyers and sellers of the stock (supply and demand) • News changes the number of people who want to buy or sell a stock, thus changing the stock’s price

14. How does news affect a stock’s price? • Negative news reduces a stock’s price because investors think the stock will be negatively affected by the news and more investors begin to sell the stock to either lock-in gains or protect against losses. • Positive news increases a stock’s price because investors believe that the company will do better than previously thought and want to capture some of this potential.

15. Check for understanding: • Target Company: BREAKING NEWS: Airline industry under fire as FAA increases taxes on flying customers! Buyers: 500 Buyers: 200 Sellers: 400 Sellers: 700 Stock Price

16. Earnings Reports • Every quarter companies issue a report in which they show how much revenue, costs, profit they made, much like an annual report. • Before these quarterly statements, equity analysts predict the earnings per share the company will announce. • Investors “price in” these predictions leading into the earnings report.

17. “Pricing In” • An assumption of the markets that says at any given time, a company’s stock price is a reflection of all available information and a combination of all future expectations of that company. • In English, this means we expect a stock price to stay where it is unless something the market (all other investors) isn’t expecting suddenly occurs.

18. Back to Earnings Reports • So let’s now apply the concept of pricing in to a stock leading into an earnings report… UAL, currently trading at $20.16 per share with $1.17 EPS Goldman Sach’s equity analysts come out and say they expect UAL to earn $1.50 EPS Because this is new information to the market, investors scramble to adjust the market price of UAL to reflect the potential to earn $1.50 EPS, coming out to $29.72

19. Back to Earnings Reports UAL, currently trading at $20.16 per share with $1.17 EPS When the earnings report comes out, investors see that UAL earned only $1.22 EPS, a gain of $.05 from last report’s, but $.28 less than expected. Will the stock price go up or down from $29.72? DOWN! The market had already priced in that UAL was going to earn $1.50, so the fact that it still beat the $1.17 doesn’t matter to investors.

20. What if… • What would happen if UAL earned $1.51 per share? Would the share price go up or down? • What would happen if UAL earned $1.50 per share? Would share price go up or down?

21. Sanity Check Episode II: Attack of the Clones • We discussed what moves a stock price: supply and demand of the actual stock. • We looked at how a stock price is calculated: by looking the last completed trade. • We talked about how the market “prices in” all available information into a stock’s price • We looked at how earnings reports and news can change a stock’s price by forcing the market to price in new information

22. Introduction to Market Cap • Market cap is a quick way to “size” a company • Calculated by multiplying share price and shares outstanding • Generally, anything with a large market cap is considered a safer investment because a large company is less likely to fail than a small one

23. Market Cap, Continued Mega-Cap Large-Cap Mid-Cap Small-Cap Micro-Cap Nano-Cap Anything over $200B (General Electric, IBM) $10B-$200B (McDonalds, Bank of America) $2B-$10B (United Airlines) $250M-$2B (First Solar) $250M or less (Tiny biomedical tech companies) Remember the T-shirt company in my dad’s garage?

24. What’s a big problem with using market cap as a size metric? • Doesn’t take into account debt! What if I have a company that makes billions of dollars every year but is funded entirely by debt?

25. Different Industries • Financial Services- Medium Growth, depends on consumer confidence • Global Industrials- Low Growth, Stable (Boeing, DuPont) • Technology/Telecommunications- High Growth, High Margin, Risky, constantly evolving (Apple, AT&T) • Health Care- Lots of M&A activity, medium growth, dependent on patent timelines (Pfizer, Eli Lilly) • Consumer Goods (Discretionary and Staples)-Stable, low growth, dependent on “blockbuster goods” (Kellogg, P&G) • Energy- Medium growth, moves with oil prices, energy demand is used as an indicator of the overall market • Materials- Strong indicator of the overall market, demand for materials shows growth

26. Financial Services • Examples: Goldman Sachs, Bank of America, JP Morgan Chase, Wells Fargo, Citigroup • Typically have mid to low growth year to year • Dependent on interest rates to make money (higher interest rates mean they make more money) • Very dependent on the overall consumer confidence in the economy

27. Global Industrials • Produce goods related to manufacturing, aerospace and defense, and construction • Examples: Caterpillar, Boeing, 3M • Largely driven by supply and demand for building construction, which is also a measure of growth in the economy (more buildings being built shows healthy spending which typically occurs in times of prosperity)

28. Technology and Telecommunications • Covers both sellers to consumers and businesses of technology products and services • Depending on the technology, may be cut in economic downturn • Historically high growth for technology products and medium to low growth for telecommunications. • Examples: AT&T, Samsung, Apple

29. Health Care • Design, manufacture, and sell drugs to hospitals, governments, and pharmacies • Reliant upon patent timelines (once a patent expires, the company has to compete with other generic drugs, driving down profit) • Very active in Mergers and Acquisitions to get new patents, as well as in lawsuits disputing patents. • Examples: Pfizer, Eli Lilly, Abbott Labs

30. Consumer Goods • Split into discretionary (which are higher growth, less stable in economic downturn) and staples (which are more stable with very low growth). • These companies follow the overall market fairly closely. • Examples: McDonalds, Kellogg, Coca-Cola

31. Energy • Companies that create and/or supply energy • Follow oil prices closely, and are good measures of global demand for energy (thus are good indicators of the overall economy) • Examples: Noble Energy, Exxon Mobil, Conoco

32. Materials • Companies that discover, develop, and process raw materials. Covers the mining and refining process, as well as chemicals. • These companies are good indicators of global growth because demand for raw materials reflects spending on construction. • Examples: DuPont, Rio Tinto, BHP Billiton

33. The Flash Crash

34. The Flash Crash • Why is the flash crash important? • High frequency trading and trading algorithms can throw the buyer/seller proportion of the markets out of balance, causing massive dips and jumps in stock prices. • It’s important to note that the same effect on the market can be achieved by a human. By buying a significant stake in a company (1%-5% or more) all at once, you can skyrocket the company’s price. Make sure you buy in increments if you plan on making a large position!

35. Sanity Check Episode III: It’s Over • You survived 7 of the industry sectors, there’s a few more, but nobody likes to learn this stuff. • We talked about what market cap is and how it is used to describe the size of a company • We had a 30 second history lesson over the Flash Crash this past May.

36. Announcements • SimComp is next Thursday in the EDS lab instead of the SCG Workshop- MUCH MORE FUN! • If you didn’t like today’s workshop, then next time’s will probably be more investing and less trading/theory/markets. • If you did like today’s workshop, then go to SIMCOMP! • PAY DUES IF YOU HAVEN’T ALREADY! • Good luck to anyone competing in UIA’s Stock Pitch Competition!