Strategic Capital Group Workshop #1: Investment Fundamentals

Agenda Creating a Company Types of Financing Financial Statements Calculating Value Exercise and Closing

Meet the USIT Shirt Company Currently run out of Parker’s dad’s garage, we are providers low cost, awful quality t-shirts to any suckers who will buy them. Currently, we aren’t producing much, and with so many other competitors, we can’t seem to make a dent on the market. However…

Breaking News: Hippies destroy all T- shirt factories in protest of something! Q2FY12 Profits Soar! – Sales up 400% – Profit doubles as customer count skyrockets – Heavy demand  need for capital to expand As the last surviving shirt company, what should USIT Co. do?

Capital Financing: Debt USIT T-Shirt Co. can raise debt to fund its growth Terminology: – Par value: Initial amount paid by investor; returned at maturity – Interest/Coupon: Amount paid periodically to investors Types of Debt: – Bonds (source - public markets) – Loans (source - privately traded or not traded)

Capital Financing: Equity USIT T-Shirt Co. can raise equity to fund its growth Terminology: – Stock: a share of ownership in a company – Initial Public Offering: initial issuance of stock by a company – Secondary Markets: investors exchanging securities Types of Equity: – Common Stock: no guaranteed dividend, vote – Preferred Stock: guaranteed a dividend, no vote

Debt vs Equity Debt Advantages: – Doesn’t seize ownership – Not as influence by market swings – Easy to raise Disadvantages: – Legal obligation to pay – Claim on assets during bankruptcy Equity Advantages: – No legal obligation to pay – No claims on assets Disadvantages: – Giving over ownership Shareholder activism Outside investors (hostile) – Voting rights

Sanity Check We’ve created a company We’ve talked about debt and equity Terminology: Common Stock, Preferred Stock, Bonds, Loans, IPO, Coupon, Par Value, Secondary Markets, Primary Markets

50/50 Split – 50% Debt Senior: more “important” – paid first Junior: less “important” – paid after senior – 50% Equity Meet the investment banker…WE’RE GOING TO GOLDMAN All common stock USIT T-Shirt Co. Raises Debt and Equity

USIT’s Finances Total Capital Gain: – 10,000,000 shares at $1.00 share – $5,000,000 in senior-secured bonds – $5,000,000 in junior bonds Expanded to 100 countries in less than one year – Indonesia, China, Germany, Chile, etc. – Factories, raw materials, human capital, more garages Continued to increase revenues at fast rate

The year rolls to a close… Public companies are required by the Securities and Exchange Commission (SEC) to produce financial statements that detail revenues, costs, profits, assets, liabilities, equity, and cash employed in the business on an annual report or “10-K”.

USIT Co.’s Statements The Income Statement: -Tells us how much we sold, what it cost us to sell it, and how much profit we made during the period. Revenue: $100,000,000 -Costs: $40,000,000 Profit: $60,000,000

USIT Co.’s Statements The Balance Sheet: -Tells us what resources are in the business (assets), how much we owe (liabilities) and the equity within the business. Assets: Cash Inventory Equipment Building Liabilities: Bonds Equity: Common Stock $10,220,000 $780,000 $2,350,000 $6,650,000 $10,000,000

Sanity Check Part 2 We’ve learned about accounting We’ve raised debt and equity for USIT Co. Terminology: 10-K, Asset, Liability, Balance Sheet, Income Statement, Revenue, Cost

Valuable Metrics Inside the 10-K Literally…how much your company earns per each share Profit Margin = Net Income (Profit) Revenue (Sales) = $60 Million $100 Million = 60% Earnings per Share = Net Income (Profit) Shares Outstanding = $60 Million 10 million = $6 per share What percentage of your sales turn are left as profits

A Wild Pokémon Has Appeared! SCG Shirts Co.! Another t-shirt company has seen our success and entered the market! Revenue: $120,000,000 Costs: $20,000,000 Profit: $100,000,000 Shares Outstanding: 5,000,000 Share Price: $2.00 EPS: (100mm) / (5mm) = $20.00

Become The Investor Which is the cheaper investment? $1.00 per share $2.00 per share

P/E- The Price to Earnings Ratio Share price is not enough! P/E: how much does one dollar of this company’s earnings cost? USIT P/E = Price (the amount you pay) Earnings per share (how much the firm makes) = $1.00 $6.00 =.17x SCG P/E = Price (the amount you pay) Earnings per share (how much the firm makes) = $2.00 $20.00 =.10x

Become The Investor So now which is the cheaper investment?.17x.10x

P/E: What Does It Mean? Widely varying interpretations – High P/E – investors value the earnings more, willing to pay more Could mean optimism – Low P/E – cheaper earnings Note: This is all relative – Compare to other companies in industry – “Cheap-er”, “costli-er”

More Ratios P/B: Price-to-Book – Book Value: Accounting value of a company’s assets – Tells us what we are paying for every dollar of assets the company owns P/S: Price-to-Sales – Tells us how much we are paying for a dollar of revenues.

Beta Beta > 1 = more volatile Beta < 1 = less volatile

Sanity Check Part 3 We’ve learned about three “Price Multiples” We’ve covered what Beta is We’ve compared two companies and decided which to invest in Terminology: Price to Earnings, Price to Sales, Price to Book, Beta, EPS, Margin

Exercise Which of the following companies would you buy? Why? CompanyPriceSharesAssetsRevenueProfitMarginP/EP/BP/S USIT$4.0010,000,000$11,000,000$100,000,000$33,300, % SCG$7.575,000,000$12,000,000$125,000,000$48,000, % UCF$82.531,000,000$19,800,000$228,000,000$49,500, % Nike$67.732,000,000$8,000,000$48,000,000$35,700, % Average$ $12,700,000$125,250,000$41,625, %