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? 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

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) Historical Earnings 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 DCF Projected Revenue$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 Margin62.1%62.7%63.3%63.6%63.8% SG&A Expenses$8,342.6$8,843.16$9,329.53$9,702.71$9,993.79$10, EBIT$8,431.8$8,933.7$9,516.0$9,984.1$10,340.0$10,546.8 EBIT Margin31.2%31.5%32.0%32.2%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 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 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, Enterprise Value $ 125, Assumptions WACC5% Tax Rate33% Exit Multiple11.08 Share Price $ Calculations Enterprise Value $ 125, Less Net Debt $ 10, Equity Value $ 115, Shares Outstanding Value Per Share $ Implied Discount15.19%

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 Valuation Step 2: Assemble company comparables P/E 2010 = 18 P/B 2010 = 1.4 P/E 2011 = 17P/B 2011 = 1.3 Estimated P/E 2012 = 16 P/B 2012 = 1.2 P/E 2010 = 22 P/B 2010 = 1.6 P/E 2011 = 25P/B 2011 = 1.8 Estimated P/E 2012 = 21 P/B 2012 = 1.5 Etc.

Compare the multiples Company P/E 2010P/E 2011P/E 2012 P/B 2010P/B 2011P/B 2012 ATT22.0x25.0x21.0x1.6x1.8x1.5x T-Mobile21.0x22.0x18.0x1.9x2.2x1.5x Sprint25.0x24.0x20.0x2.5x2.2x0.6x Average22.7x23.7x19.7x2.0x2.1x1.2x Verizon 18.0x17.0x16.0x 1.5x1.4x1.3x

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 Valuation Verizon 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 = $ 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 4 th, 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