Strategic Capital Group Workshop #1: Stock Pitch Composition

What does a pitch look like?Investment Thesis

Company Overview and Advantage

Industry and Market Analysis

Valuation

Risks

The Investment Thesis

• Reasons to invest in a company:– Value Investing- picking investments that are

trading for less than their intrinsic value. – Growth Investing- picking investments that have

potential to grow more than the market already believes.

– Fixed-Income Investing- picking stable investments that can provide returns even when stagnant.

Which is the riskiest? The safest?

Who might be interested in each style of investing?

Why do you want to invest in this company?

The Investment Thesis• Does the stock fulfill a strategy in the overall

portfolio?– Diversification- risk management strategy

whereby losses in some securities is offset by gains in non-correlated securities

Name two stocks that do not correlate

Company Overview

• What does it do?• How does it make money?• Who are its competitors?

• Who’s running it?• Why this company and not

competitors?

Company Overview: Key Statistics

• Serve as a quick financial snapshot of the business to assess its health

• We want to look at:– Are they in a lot of debt?– Do they have any cash?– How much money have they made in the past years?– What do their margins (profitability) look like?– What is the scope/size of the business?– Where does it operate?

Key Statistics You Saw Last Meeting

2006 2007 2008 2009 2010 2011 $-

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

3,544

2,395

4,313 4,551 4,946

5,503

Earnings History

2006 2007 2008 2009 2010 20110

5,000

10,000

15,000

20,000

25,000

30,000 Historical RevenueFranchised

revenues

2006 2007 2008 2009 2010 201129,50030,00030,50031,00031,50032,00032,50033,00033,50034,000

Total Restaurants

2006 2007 2008 2009 2010 20110.0%5.0%

10.0%15.0%20.0%25.0%30.0%35.0%

21.2%17.0%

27.4%30.1% 31.0% 31.6%

Operating Margin

Other Key Statistics We Can Use

Profit Margin =Net Income (Profit)

Revenue (Sales)

Current = Ratio

Current Assets (assets we can turn into cash in one year or less)

Current Liabilities (debts we have to pay this year)

HistoricalEarnings per Share =

Net Income (Profit)

Shares Outstanding

Competitive Advantage

• Competitive Advantage- a distinct, unique advantage a company has over its competitors, allowing it to generate more revenue, achieve better margins, or hold customers better than others.

What are some examples of this we can see in real companies?

Competitive Advantage: Exercise

Sanity Check

• We’ve discussed different investment ideologies• We’ve covered what to look for in a company

overview and what statistics to look at• We’ve discussed examples of competitive

advantages

Key Terms: Value Investing, Fixed-Income Investing, Growth Investing, Diversification, Competitive

Advantage

Industry Analysis- Porter’s 5 Forces

Intensity of

Rivalry

Threat of New

Entrants

Bargaining Power of Buyers

Threat of Substitutes

Bargaining Power of Suppliers

Market Analysis

• Questions to ask– Is instability in a region going to hurt its margins?– Are conditions pushing investors out of one asset

class and into another?– Are there untapped markets waiting for this

company?• Focus on global news and ask yourself if this

will influence your company.

Market Analysis: Exercise

• How can a Euro-zone debt crisis and Chinese growth slowdown influence a company like Verizon?

• How does instability in the Middle East impact margins of American Airlines?

Valuation

• The big cheese: what investors really care about. Is my investment going to make money?

• Intrinsic vs. Relative Valuation:– Intrinsic: Valuing a company based on how much

revenue/cash/profit it will generate in the future– Relative: Valuing a company by comparing it to its

peers

Valuation

Intrinsic Valuation• Factors in a company’s

future profit potential.• Both qualitative and

quantitative brought together

• Concerned about cash flows, as investors, we ultimately care about tangible money that can be used to pay us

Relative Valuation• Factors in similar

competitors in the market• If market averages for a

trading multiple (P/E, P/B, P/S) are higher than your company’s, this is a sign that your company is undervalued compared to the rest of the market

Intrinsic Valuation: How do we do it?

1.) Understand the company– Revenues, profitability, trends, management quality, new

products, market competition, etc.2.) Build a model

– Common practice is to build a Discounted Cash Flow Model (DCF) that forecasts how much money the company will generate in the future, then finds out what that cash is worth right now.

3.) Put a price tag on the company– Find out what a company that can generate X amount of cash over

the next 5 years is worth through the model and compare to the current share price. If your implied share price from the model is less than the current market price per share, you should invest.

Example of a DCFProjected

2011 2012 2013 2014 2015 2016Revenue $27,006.0 $28,356.3 $29,774.1 $30,965.1 $31,894.0 $32,531.9 Cost of Sales $10,231.6 $10,579.5 $10,928.6 $11,278.3 $11,560.3 $11,791.5 Gross Profit $16,774.4 $17,776.8 $18,845.5 $19,686.8 $20,333.8 $20,740.4 Gross Margin 62.1% 62.7% 63.3% 63.6% 63.8% 63.8%

SG&A Expenses $8,342.6 $8,843.16 $9,329.53 $9,702.71 $9,993.79 $10,193.67 EBIT $8,431.8 $8,933.7 $9,516.0 $9,984.1 $10,340.0 $10,546.8 EBIT Margin 31.2% 31.5% 32.0% 32.2% 32.4% 32.4%

NOPAT $5,649.3 $5,985.6 $6,375.7 $6,689.3 $6,927.8 $7,066.3 D&A $1,329.6 $1,412.4 $1,468.9 $1,498.3 $1,513.3 $1,513.3 Change in NWC ($550.0) $750.0 ($575.0) $500.0 ($225.0) $150.0 CapEx $2,730.0 $2,900.0 $3,016.0 $3,076.3 $3,107.1 $3,107.1 FCF $4,798.9 $3,748.0 $5,403.6 $4,611.3 $5,558.9 $5,322.5 DCF $3,569.5 $4,901.2 $3,983.4 $4,573.4 $4,170.3

Terminal Value $ 133,625.04

Enterprise Value $ 125,896.49

Assumptions

WACC 5%

Tax Rate 33%

Exit Multiple 11.08

Share Price $ 98.62

Calculations

Enterprise Value $ 125,896.49

Less Net Debt $ 10,164.70

Equity Value $ 115,731.79

Shares Outstanding 1018.6

Value Per Share $ 113.62

Implied Discount 15.19%

Sanity Check

• We’ve learned Porter’s 5 Forces, a method of evaluating an industry

• We’ve learned that global market forces should be considered when evaluating a stock

• We’ve learned what intrinsic valuation is and received a rough outline of how to use it

Key Terms: Porter’s 5 Forces, Intrinsic Valuation, Relative Valuation, Discounted Cash F

Relative Valuation: How do we do it?

1.) Determine peers of your company– Look at industry, size, geography– What good is comparing Apple to Verizon?– Competitors are on the 10-K’s most of the time

2.) Assemble company multiples or “comparables”– Find multiples like P/E, P/B, EV/EBITDA for your company and its

chosen peers– Resources for this: Yahoo Finance, Bloomberg, CNBC

3.) Compare multiples between companies– For value investing, you want your stock to be trading at less than

market value (lower multiple than the averages)– Based on these numbers, we can calculate an implied share price

Relative Valuation

Target company:

Step 1: Assemble peers of the company

Relative ValuationStep 2: Assemble company comparables

P/E 2010 = 18 P/B 2010 = 1.4P/E 2011 = 17P/B 2011 = 1.3Estimated P/E 2012 = 16 P/B 2012 = 1.2

P/E 2010 = 22 P/B 2010 = 1.6P/E 2011 = 25P/B 2011 = 1.8Estimated P/E 2012 = 21 P/B 2012 = 1.5

Etc.

Compare the multiples

Company P/E 2010 P/E 2011 P/E 2012 P/B 2010 P/B 2011 P/B 2012

ATT 22.0x 25.0x 21.0x 1.6x 1.8x 1.5x

T-Mobile 21.0x 22.0x 18.0x 1.9x 2.2x 1.5x

Sprint 25.0x 24.0x 20.0x 2.5x 2.2x 0.6x

Average 22.7x 23.7x 19.7x 2.0x 2.1x 1.2x

Verizon 18.0x 17.0x 16.0x 1.5x 1.4x 1.3x

So we know it’s undervalued…But how do we know by how much?

BY USING ALGEBRA!We make a key assumption to determine an implied share price through multiples:• In the long run, our multiple will equal the industry average for that

same multiple, so…

Relative ValuationVerizon Price

Verizon Earnings Per Share= Industry Price to Earnings

Multiple

If we want to find what our stock is worth in comparison to the industry,

solve for Verizon Price.

Verizon Price = 23.7x X $2.15

Verizon Price = Industry P/E X Verizon EPS

= $ 50.93

So based on the 2012 Price to Earnings multiple, Verizon should be worth $50.93 an

implied discount of 11% to its current price of $45.90

Risks• Every company has something wrong with it or has a

chance for failure• Found in 10-K, but we want real risks• Two kind of risks:

– Company-specific– Industry-wide– Technically market-wide risks too, but those aren’t relevant as

they are going to be present in nearly every potential company.• You’re not helping anyone if you give bullshit risks, it can

only hurt you if you look past serious problems with the company.

Sanity Check

• We’ve learned how to perform a relative valuation of a company

• We’ve learned how to extrapolate a share price from a multiple comparison

• We’ve learned the two kinds of risks and the value of being honest

Announcements

• PAY DUES• UIA Stock Pitch Competition coming up on Sept. 29,

make a USIT team and go kick ass.– Need help building your pitch or making it a bit more in-

depth? Talk to any SCG member• SimComp takes place on October 4th, next workshop

we’ll be working on how to trade on news and trade quickly maybe

• Stock Pitch teams will be formed before next meeting- notifications will be sent by EMAIL