TradeQuest Workshop B Valuation, Analysis & Research Record-keeping

Philosophy of Valuation Value of asset is irrelevant so long as “bigger fool” is available? Value of asset is irrelevant so long as “bigger fool” is available? An investor does not pay more than the asset is worth An investor does not pay more than the asset is worth Painting or sculpture is not same as financial asset Painting or sculpture is not same as financial asset Price paid is related to the level and expected growth in cashflow that the asset can generate Price paid is related to the level and expected growth in cashflow that the asset can generate

Myths of Valuation “Since valuation models are quantitative, valuation is objective” “Since valuation models are quantitative, valuation is objective” “The more quantitative a model, the better the valuation” “The more quantitative a model, the better the valuation” “A good valuation provides a precise estimate of value” “A good valuation provides a precise estimate of value” “The market is generally wrong” “The market is generally wrong”

Role of Valuation Fundamental analysis – value of firm can be determined by financial characteristics Fundamental analysis – value of firm can be determined by financial characteristics Franchise buyers – look for value in firms that are stable and predictable Franchise buyers – look for value in firms that are stable and predictable Chartists – information about trading patterns is as important as financial information Chartists – information about trading patterns is as important as financial information Information traders – anticipate news and market reaction Information traders – anticipate news and market reaction

“Find the Jewel” Financial Statement Analysis Financial Statement Analysis Valuation Tools Valuation Tools Market Data Market Data

Financial Statement Analysis Balance Sheet Equity Equity Debt Debt Assets Assets Leverage Leverage Income Statement Operating Margins Non-Operating Items One-Off Items Trend Cashflow Statement Indicator of profitability of core business Indicator of profitability of core business

Balance Sheet Company XXCompany YY Assets: Current 3,754 21,927 Other Assets 278 4,897 Fixed Assets ,471 Total 5,172 33,295 Liabilities: Current 1,810 22,537 LT Debt 138 3,442 Equity 3,224 7,316 Total 5,172 33,295

Income Statement Company XXCompany YY Net Revenue2,360 10,979 Net Expenses2,027 10,205 Operating Income Other Items (102) (153) Net Income Earnings per share Stock Price Price/Earnings

Cashflow Statement Company XX Company YY From Operations1,526 4,321 From Investments (1,169) (3,012) From Financing (195) (1,122) Net Cashflow

Ratio Analysis - Gross Margin Net Earnings - Cost of Sales Net Sales - Debt/Equity Long Term Debt Stockholders Equity - Interest Cover Net Earnings from Operations Interest Expense

Ratio Analysis Earnings Per Share Net Earnings No. of Outstanding Shares Price Earnings Share Price Earnings Per Share

Valuation Tools Financial Statement ratios Financial Statement ratios ROE, ROA … ROE, ROA … CAPM (Capital Asset Pricing Model) CAPM (Capital Asset Pricing Model) Discounted cashflows Discounted cashflows Dividend models Dividend models Comparables to similar firms or to industry Comparables to similar firms or to industry Quantitative or econometric models Quantitative or econometric models Option pricing Option pricing

Market Data SEC Filings SEC Filings Analysts Recommendations Analysts Recommendations Company Conference Calls - Earnings Guidance Company Conference Calls - Earnings Guidance Quarterly Earnings Report Quarterly Earnings Report Economic Indicators Economic Indicators

Summary Finding undervalued investment is difficult Finding undervalued investment is difficult Markets behavior is irregular -- not perfect Markets behavior is irregular -- not perfect Size of firm Size of firm “January effect”, “weekend effect”, “holiday effect” “January effect”, “weekend effect”, “holiday effect” Realize that professionals are not consistently high performers Realize that professionals are not consistently high performers Net result: big gap between theory and practice Net result: big gap between theory and practice