Feb 12 2010 Sap

Stock Analyst Program 2010

Driss [email protected]

Jamie [email protected] in Investment Management, Wharton Exchange Fall 2009

February 12, 2010

Winter 2010 Overview Next meetings: March 5, 12, 19; Room 045 (2pm)


Date Topic Date Topic

Jan 29 Overview, Valuation, Resources to Start Mar 5 More Applied Valuation

Feb 5 What is Price Action?Multiples Analysis

Mar 12 Applied Technical Analysis (equities, commodities, FX)

Feb 12 Stock Screening & Risk Management Mar 19 TBD

Feb 19 Cancelled: Reading Week Mar 26 Cancelled

Feb 29 Cancelled: Reading Week Apr 2 Final SAP Presentations

Agenda

Research Report Overview

Where to Trade

Stock Screening

Risk Management

How To Start…

Discussion


Research Report Overview

Research Report Composition The key to writing a coherent SAP research report is understanding and articulating an investment time horizon

- Refer to previous reports on the MIC website: Resources > SAP References


Evaluation Criteria (1)

1. Choice of industry articulated relative to other industries that would be affected by the general economy in a similar way. For example, the drug delivery industry and the drug manufacturing industry are affected by the same external economic conditions; thus it should be clear as to why one versus the other.

2. This would include use of ratios specific to industry, dcf valuation, comps, precedents, etc... This would also include quantifiable identification of relevant catalysts and earnings growth potential specific to the company.

Research Report Evaluation

Industry Analysis 30% Presentation/Research Paper 10%Identification of key metrics and ratios /10% Organization /3.3%Identification of key trends /10% Flow /3.3%Choice and rationale for industry (1) /10% Content /3.3%

Stock Analysis 40% Technical Analysis 20%

Quality of valuation & depth of research (2) /20% Clear investment horizon /5%Investment rationale /20% Entry & exit strategies /15%

Total 100%


Where to Trade

Where to Trade

Online Broker Ratings – Trading (Barron’s)


Source: http://online.barrons.com/article/SB120554254483438485.html

Where to Trade

Online Broker Ratings – Investing (Globe & Mail)


Source: http://www.theglobeandmail.com/report-on-business/online-broker-rankings/the-11th-annual-online-broker-survey/article1348448/

• Watch out for minimum balance, minimum activity, fund removal flexibilitydue diligence!

• List does not include brokers who don’t offer registered accounts (i.e., Interactive Brokers)

Where to Trade

• Trading costs contribute to your tax bill (unless you are trading a registered account)

• Discount brokerage analysis: those who traded the most earned returns no higher than those who traded the least (in fact, they earn less after brokerage costs)

• Mutual funds with the highest portfolio turnover rates have underperformed by 1.8% annually the past 10 years

• Pension-fund study: on average, funds would raise annual returns by nearly 1% if the manager had gone on 12-month vacation!

• Why? Investors sell winners too soon, hold losers too long (prospect theory), overconfidence, impatient

• “The stock market serves as a relocation center at which money is moved from the active to the patient” – Warren Buffett

But, Beware...


Source: http://online.wsj.com/article/SB10001424052748704337004575059960489864970.html?mod=djintinvestor

Stock Screening

Stock Screening

• Based on the stock’s intrinsic value- Low PE, P/BV, P/CF multiples- Long term time horizon

Value Investing Growth Investing

Contrarian InvestingGARP Investing

Risk preference, time horizon, skill set, and comfortability determine the best investment style to employ

• Seeking future growth potential and earnings strength

• A hybrid combination of growth and value strategies

- Peter Lynch- Emphasis on the PEG ratio

• Goes against conventional market wisdom- Crowd behaviour creates mispricing


Stock Screening

• 1) Adequate size: $100MM sales in 1970

• 2) Sufficiently strong financial condition: current ratio ≥ 2

• 3) Earnings stability: no losses past 10 years

• 4) Dividend record: 20 years of dividend payments

• 5) Earnings growth: net income increased by 1/3+ on per-share basis for past 10 years, using 3 year moving averages at beginning and end

• 6) Moderate P/E ratio: < 15x earnings for past 3 years

• 7) Moderating price-to-assets ratio: current price ≤ 1.5x book value

• Further information: The Intelligent Investor, Security Analysis (books)

Ben Graham (Value Investor)


Stock Screening

Warren Buffett - First Stage Analysis

• Take a look at the nature of the company’s business-A viable company will have the size, depth, and breadth of brand recognition

• Inflation sustainability and ability to pass on costs-Look for ability to increase cost of main product relative to inflation

• Products are understandable and business lines are comprehendible

• Company is able to have predictability in terms of earnings -Earnings growth or expansion is also a requirement - A short dip in earnings growth is acceptable given certain circumstances

• Consideration given to companies with conservative finances-This includes low levels of debt relative to net income

• Close scrutiny towards managements use of retained earnings towards shareholder wealth-ROE over the past 10 years should be greater than 15% on average

• High free cash flow and low capital expenditure should not be excessive

Source: John Reese, Todd Glassman; “Market Gurus.”


Warren Buffet - Second Stage Analysis (Properly Priced?)

• Step 1. Calculate IRR- Determine through EPS/Market Price

• Step 2. Compare calculation made in step 1 to the long term bond yield- Exceptions can be made if company’s expected yield growth is high

• Step 3. Calculate Future EPS: First calculate 10 year average ROE from balance sheet figures, then calculate average dividend payout ratio in order to find the average retained earnings

- Since % ROE retained = (Avg ROE/ 100) ×(1- (Avg payout/100),- Multiply ROE retained by 100 and use as interest rate to solve for FV (equity per

share) given PV as current equity per share - Take FV (equity per share) multiply by 10 year average ROE to get future EPS

• Step 4. Use the above future EPS and multiply by average PE (last 10 years) to get projected future stock price

- Include dividend pool to stock price by taking company’s estimated EPS for current year adjusted for growth rate in dividends to give you a projected EPS

Stock Screening



Warren Buffett - Second Stage Analysis Cont.

Stock Screening

• Step 4 cont’d. - Use the projected EPS in each year, multiply by (average dividend payout/100) . - Use the sum of the above value and add back to the stock price calculated above

• Step 5. Use the above calculations to determine expected return using the ROE methodPV- Current StockFV- Future stock price adjusted for dividends from step 4.N- number of periods (in this case 10)i- Solve

Refer to ratio criteria to determine expected return threshold

• Step 6. Determine the expected return using the EPS growth (average) - First take the average EPS growth for last 10 years- Project the 10 year EPS figure by using this growth rate and current EPS- Determine Future stock price by multiplying by 10 year PE (average)

• Step 7. Calculate expected return as per step 5, using the EPS growth method

• Step 8. Compare the results using the average of the expected returns from both the ROE and EPS method



Stock Screening

• 1) 5-year average annual EPS growth rate ≥ 20% but ≤ 30%

• 2) D/E ratio of 0.33 – 1.00 (the lower the better)

• 3) PEG ratio < 1 (trailing P/E ratio divided by current EPS)

• 4) Pretax profit margin consistency

• 5) Little institutional ownership (<50% preferred)

• 6) Flat or increasing inventory turnover

• Further information: One Up on Wall Street, Beating the Street (books)

Peter Lynch (GARP Investor)


Stock Screening

William O’Neal (Growth Investing)

Current Quarterly Earnings Growth (Q1- Q5) Relative Strength 1. < 18% Fail 1. < 80 Fail 2. ≥ 18% Pass 2. ≥ 80 Pass

Annual Compounded EPS Growth Rate Relative Strength of peer1. < 18% Fail 1. < 80 Fail 2. ≥ 18% Pass 2. ≥ 80 Pass

Earnings Consistency Industry Relative Strength 1. No dips in earnings Pass 1. < 70 Fail 2. > 1 dip Fail 2. ≥ 70 Pass

Return on Equity1. Price within (+, -) 15% of 52- Week High Pass 1. < 17% Fail 2. Price within other range of 52- Week High Fail 2. ≥ 17% Pass



• Cut losses at 7-8% loss (high risk strategy)

Stock Screening

• Thesis: investors overvalue popular stocks and undervalue unpopular stocks

• 1) Find ‘shunned’ stocks: low P/E, low P/B, low price/dividend, low P/CF

• 2) Separate investor overreaction from truly bad investments• Look for: high current ratio, high ROE, high pre-tax profit margins, low D/E

• Further information: Contrarian Investment Strategy (book)

David Dreman (Contrarian Investor)


Stock Screening

Value vs. Growth (P/B Deciles vs. 5-Year Annualized Return)


Source: “Value vs. Glamour: A Global Phenomenon” – Brandes Institute (2008)

Stock Screening

• http://finviz.com/screener.ashx• Descriptive, fundamental, technical screens

• http://www.stockhouse.com/tools/?page=%2FfinancialTools%2Fcd_searchtool.asp%3Ftype%3DAdvanced%26page%3DcdInputPage

• Many different exchanges, lots of fundamental screens

• http://www.google.com/finance/stockscreener#c0=MarketCap&c1=PE&c2=DividendYield&c3=Price52WeekPercChange&region=us&sector=AllSectors&sort=&sortOrder=

• Graphical distributions

• Bloomberg Terminal• Comprehensive screener

Useful Stock Screeners


Risk Management

Risk Management

• " I haven't met a rich technician" - Jim Rogers• " I always laugh at people who say "I've never met a rich technician" I love that! Its such an arrogant, nonsensical response. I used fundamentals for 9 years and got rich as a technician." -Marty Schwartz

• "Diversify your investments“ - John Templeton•"Diversification is a hedge for ignorance" - William O'Neil

• "Don't bottom fish" - Peter Lynch

• "Don't try to buy at the bottom or sell at the top“ - Bernard Baruch

• "Maybe the trend is your friend for a few minutes in Chicago, but for the most part it is rarely a way to get rich” - Jim Rogers

• "I believe the very best money is made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all your money by playing the trend in the middle. Well for twelve years I have been missing the meat in the middle but I have made a lot of money at tops and bottoms." - Paul Tudor Jones

• "I'm more concerned about controlling the downside. Learn to take the losses. The most important thing about making money is not to let your losses get out of hand." - Marty Schwartz

• "Rule number one of investing is never lose money. Rule number two is never forget rule number 1" -Warren Buffett


Quotes

Risk Management

Never Lose


Original Balance 100

Loss New Balance Gain required10% 90 11%20% 80 25%30% 70 43%40% 60 67%50% 50 100%60% 40 150%70% 30 233%80% 20 400%90% 10 900%

Original Balance 100

Gain New Balance Breakeven cushion10% 110 -9%20% 120 -17%30% 130 -23%40% 140 -29%50% 150 -33%60% 160 -38%70% 170 -41%80% 180 -44%90% 190 -47%

….but pick your tolerance level for losing, @ which point you need to stop and reevaluate yourself, your rules, and your strategy

Risk Management

Considerations


• How much capital is placed vs. how much capital is risked per trade• What is the effect on the portfolio, opportunity cost of getting into other trades etc.

• When NOT to trade?• Look at your equity curve – do you trade the same on losing and winning streaks?• When do you have a take a loss in order to avoid a larger loss?• Do you change your plan AFTER you get into a trade?• How does your position sizing change with accumulated new profits/losses

• Factors• Leverage used• Volatility of asset traded

Max RiskPotential Profit

Risk Management

Example


32 pips73 pips

BUYif channel is respected

TAKE PROFITbelow session high

STOP LOSSbelow previous low

ACTIVATE TRAILING STOP

Max Risk

Potential Profit

0.43

73 pips32 pips 2.28

now

Risk Management

More Considerations


• Look at portfolio globally and correlations amongst different holdings

• Positions with high correlations are the same as leverage• Positions with negative correlations can lower risk & return

• Difference between winning and losing:• More due to limiting mistakes than to going into good trades

• Remember that cash is also a position

• Plan your trades. Trade your plan• Often said, not always done…

• Consistency is never over done

Risk Management

Equity Curve


Risk Management

Equity Curve


Risk Management

Equity Curve


Risk Management

Equity Curve


How to Start…

How to Start…

• Macroeconomy• David Rosenberg, Chief Economist & Strategist, Gluskin Sheff

• Go to GluskinSheff.com to sign up for morning newsletters (often bearish)• SeekingAlpha.com > The Macro View (can e-mail subscribe)• Economist.com > Business and Finance

• Industry Analysis [VPN required]• http://www.mcgill.ca/library/library-findinfo/subjects/management/industry/ >

NetAdvantage > Industry Reports• Or, > Mergent Online > Industry Reports

• Bloomberg terminal: RSE <go> > Search by Industry• SeekingAlpha.com > Stocks & Sectors

• Company Analysis• Finviz.com > Screener• Google.com/finance > Screener• http://www.mcgill.ca/library/library-findinfo/subjects/management/industry/ >

ValueLine [old school, but great info in one page]• Bloomberg terminal: ‘ticker’ <go> > Fundamentals & Estimates > ANR

Important Resources


Date Topic Date Topic

Jan 29 Overview, Valuation, Resources to Start Mar 5 More Applied Valuation

Feb 5 What is Price Action?Multiples Analysis

Mar 12 Applied Technical Analysis (equities, commodities, FX)

Feb 12 Stock Screening & Risk Management Mar 19 TBD

Feb 19 Cancelled: Reading Week Mar 26 Cancelled

Feb 29 Cancelled: Reading Week Apr 2 Final SAP Presentations

Research Report Composition Next meetings: Room 045; March 5, 12, 19 (2pm)
