1. 1 Fundamental Equity Analysis Chris Argyrople, CFA Concentric Investment Management LLC

2. 2 Humor & Caution: DLJ’s Springsteen Theory of the Dow DLJ noted in their April 17, 2000 research report that: The Dow outperformed the NASDAQ after leg 2 of the Springsteen Tour Conclusion: –1) The Boss Rules –2) Humor is Acceptable –3) SOMETIMES IT IS MUCH TOUGHER TO DISCERN WALL STREET’s BS THAN IN THE SPRINGSTEEN EXAMPLE

3. 3 Why Take this Class? Develop Rigorous Analytical Approach Towards Evaluating an Equity Integrate Concepts from: Corporate Finance, Accounting, and Strategy Profit Improve Thinking Skills

4. 4 Where is the Market Going?? I have no idea where the Dow or S&P will trade in the next year Long Term: earnings will drive stock prices and earnings have risen about 9% per year over time This Class = Forecast Results for Individual companies, not the market IT IS A STOCKPICKER’S MARKET GOING FORWARD, SO YOU ARE IN THE RIGHT CLASS

5. 5 Allocate $1,000 between these 3 Company A: P/E ratio 15, consensus growth estimate 17%, analyst dispersion around consensus of 12%, payout ratio 0%. Company B: P/E ratio 2, consensus growth estimate 0%, (20 analysts all in agreement), payout ratio 100%. Company C: P/E ratio 10, consensus growth estimate 30% (20 analysts all in agreement), payout ratio 0%.

6. 6 Course Goals Be able to thoroughly analyze a company Learn how to Integrate all knowledge into a portable “toolkit” for analysis Help Train the Next Peter Lynch :-) NOTE: The great student will take the science to a higher level than the teacher

7. 7 How/What Will You Learn? Learn from Yourself, about Yourself Learn from Classmates (don’t minimize) Learn from Professor TURN MISTAKES INTO LEARNING My Goal / Deliverable: Students can prepare a professional securities analysis by end of session Destination is > Interim Progress

8. 8 My Finance Philosophy Models are Important Analysis augments Thought Accounting is Important Details are Key, but stop when you reach diminishing returns. Logic and Thoughtfulness are more important than modeling I would rather be Warren Buffet than Fisher Black Strategy is Equally important as Finance

9. 9 Two Approaches to Research Traditional MBA Do some ratios Quick Answers EASY WAY This Class Sleuthing Thought & Logic Analytical Models CORRECT WAY

10. 10 What to Expect Hard Work Boring Data Gathering and Data Entry. Modeling COMBINED with Logic. The Models will not give you the answer. I could give you a model right now, and you would not know what to do with it.

11. 11 What I Expect Lots of Hard Work Plenty of Participation Debate and Differing Viewpoints More Hard Work I Expect you to be Good at Both the Modeling and the Thinking. These are 2 different things. Example: How do you Calculate this E(r)?

12. 12 About The Markets Market Timing is nearly impossible The Last 15 Years have been Incredibly easy to make money The Next 15 Years will be Stockpickers Markets Thus, Fundamental Analysis Quant models face a difficult future because, by definition, quant models eliminate efficiencies they exploit

13. 13 Characteristics of Good Analysts Intelligence –Can’t be Taught, BUT it can be offset by other factors –Buffet is rumored to be a genius –Geniuses can see what others don’t Work Habits: Work Smart & Hard, Focus Independent Thinking / Guts to Act Experience & Training –Learn from Mistakes, Be Open Minded Passion For the Work

14. 14 MODEL BUILDING EDGAR (Elec. Data Gather. & Retrieval) Data Entry -- actuals from 10Ks & 10Qs Try to Pick Companies / Industries that have lots of data -- Data drives good fundamental models. Don’t want to multiply last years revenue by 6%.

15. 15 Pick A Company / Industry Pick Industries where Data is Available –Maybe you work in that industry –Want to Drive Revenue with Fundamental Data Pick Something you Like At my Firm, we like High Fixed Costs, Operating Leverage, Data Availability DON’T WASTE TOO MUCH TIME CHOOSING A COMPANY; WILL LEARN FROM : Your Firm, Classmates, & Prof.

16. 16 The Class Will Cover 1) Cash Flow Methodology & Valuation 2) EVA TM, Economic Value Added Model c Stern, Stewart & Co. 3) Strategic Management & Valuation 4) Industry Analysis

17. 17 What Moves Stock Prices? Rank These Items: Press Releases Earnings Growth Buyers in the Market The “Big Boys” : Mutual & Pension Funds Announced Stock Buyback Splits Dividend Increases Change to a “New Economy Business Plan”

18. 18 Pattern Recognition is Key in Stockpicking Pay attention to patterns in the markets Always think: WHAT MOVES STOCKS? What happens to Financials, Homebuilders, Retailers when interest rates rise? Why are falling same store sales GREAT for retail stocks? Need Many Mental Models: “ To a Man with a Hammer, Every Problem Looks Like a Nail”, Charlie Munger -- You need to draw on many experiences for successful investing

19. 19 Introduction to Valuation THE VALUE OF ANY INVESTMENT EQUALS THE PRESENT VALUE OF THE FUTURE CASH FLOWS TO THE BUYER This holds for all Investments : Stocks, Bonds, Real Estate, Beanie Babies etc. i = correct discount rate that reflects the risk of the cash flows

20. 20 DCF Valuation Discounting future cash flows to a present value is called DCF Valuation DCF Valuation is ALWAYS CORRECT given the following assumptions: 1.You can correctly forecast the Future (even many years out) 2.You use the correct discount rate

21. 21 Problem with DCF Valuation In 1977, I was in 8 th Grade Experts told us: 1.The Russians will take over America 2.Oil was going to $100 a barrel 3.Computers will take jobs away from humans 4.By 1990: the 4 Day Workweek ! If you can Predict the Future, then use DCF and Drop this Course

22. 22 Reasons for Fundamental Research in an Efficient Market 1.KEEP YOUR JOB (#1 Reason) 2.Develop E( r ) Forecasts 3.FIND OCCASIONAL INEFFICIENCIES & ATTRACTIVE SITUATIONS (this is the real #1 Reason)

23. 23 My Recommendation Do Lots of Fundamental Research When you have no alpha, diversify and keep costs low (index) When you have alpha, throttle it. Remember, you are in school so you can get a high paying job. If you are worth the pay, you will reap the excess returns from your best ideas. Implement your best ideas in a big way. Are your Ideas Worth the Paycheck?

24. 24 The Buffett Method Put all your eggs in one basket, and watch that basket very closely. Concentrated Positions (never less than 9 stocks) Intense Research, Lots of Knowledge Note: A good Portfolio will be: 1)Industry Diversified 2)Maybe have 30 stocks

25. 25 Homework Due Pick a company -- Domestic USA only Build an equity model At least 2 full years of historical data ( 8 quarters: Income & Cash Flow Statem) Full Year Forecast for Current Year (quarterly) Short writeup and investment thesis & recommendation (Buy or Sell) Hand in on-time: Hardcopy PLUS Optional email of model

26. 26 Homework (continued) Use trailing and forward ratios to formulate your investment thesis & recommendation Only most recent quarterly Balance Sheet (for now) Don’t worry: you’ll get plenty of practice !

27. 27 Textbook is Optional The textbook is Optional but recommended Distributed in class Price $65 cash / check / your good word Must order text via email Length continually varies, but approximately 280 pages

28. 28 About the Instructor Adjunct Professor (not full-time) New Analyst: 10 years at Fundamental B.S. Engineering, Rensselaer Polytech M.S. Finance, M.I.T. Sloan 2 years: Equity Quant: Acadian Asset Mgt 4 years: Corp. Finance: Ford Motor Co. 1.5 years: Asst. Port Mgr: Atlas Investm. 4 years: Analyst: PAR Capital Mgt Co-Founded Delta Partners in April 1999 Co-Founded Concentric Investments January 2005 Analysis of this Career:……………………….

29. 29 Instructor (continued) Internships: Travelers (foreign equity quant); Colonial (bond trader) Willing to stay late after class to answer questions Have difficulty finding people jobs, but you can always ask (my contact list is finite, but the students regenerate yearly)