Mic Powerpoint 3

Stock Analyst ProgramFall 2008

Farid GuindoMIC VP Portfolio Management

October 17th 2008

Executive Summary

SAP Overview • Current Portfolio Overview•How to Play & Win the Game

Valuation Methodologies• DCF Valuation• Comparables Method• Precedent Transactions

Investment Styles•Value Investing•Growth Investing •GARP•Momentum

Stock Analyst Program 2008

Appendix

SAP Overview


SAP Portfolio

Current Holdings


Current MIC Portfolio Bottom line: Performance be better!


Current MIC PortfolioBenchmark Returns versus MIC portfolio

MIC Portfolio

CDN T-Bills

S&P/TSX

S&P 500

DJIA

This year the SAP program will be comprised of the following: A weekly trading challenge alongside a final stock pitch at semester end

How to Play the Game

Semester End Stock Pitch

• Research report composition

• Presentation

• Important dates

• Evaluation Procedure− Valuation comprehensiveness− Relative ranking− Consistency−80% weight including 30 % for presentation

• Composed of 4 weekly sessions starting on Oct 27th ending on November 17th

- Send ideas on the Sunday preceding the start of the week

• Evaluation Procedure− The market will determine the winner− Total of 20% weight to final overview


The Trading Challenge

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

Research Report Composition Stock Analyst Program 2008

Stock Valuation Methodologies


Overview Valuation methodologies are not mutually exclusive and in fact are more effective when employed simultaneously

• Sector coverage is important in determining which methodology to use and what to take into account

• Determine the stream of revenue being generated• Derive weighted average cost of capital (WACC) for firm or rate of return specific to asset• Risk cash flows according to WACC

-Assumes time value of money -General assumptions on terminal value are used

Discounted Cash Flow (DCF)

Comparable Transactions

Precedent Transactions

Valuation MethodologiesStock Analyst Program 2008

• Determine from past transactions similarities i.e. industry composition, level of risk, size of the transaction• Filtering through the assumptions being used for the precedent transaction allows transparency in your own valuation• The more transactions the better

-Relevant private transactions may or may not be available for use

• Develop case studies for the most relevant transactions to determine an appropriate range to use

- Put more weight on transactions with similar assumptions

• Determine the relevant industry classification •Use of industry based ratios •If specific industry does not exist, work backwards

• Relative comparisons are key; company vs. company & company vs. industry average • Gives a brief idea of where company lies and who key competitors are

- Allows us to determine best/worst of breed

Investment Styles

•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

Summary of Various Investment Styles Personal risk preference, time horizon, and skill set determine the best investment style to employ


•Seeking future growth potential and earnings strength

• A hybrid combination of growth and value strategies

-Brought to main stream use by Peter Lynch- Emphasis on the PEG ratio

• Goes against conventional market wisdom- Crowd behaviour creates mispricings


A Closer Look at Value Investing

Time Horizon

Risk Level

Effort

Benjamin Graham Warren Buffet

- Low risk at deep value - Relatively low risk investments

- High initial effort for - Highly selective in fundamental analysis valuation and screening

- Low effort on a continuing basis

- Long term investment - Lifetime ownershipstrategy i.e. (buy & hold) Buy, hold & hold some more

- Diversification is key

Both Graham and Buffet are fundamental value investors who use long term strategies to benefit from relatively cheap companies

1. Sourced to John Reese, Todd Glassman; “Market Gurus.”


Fundamental Value Investing

Benjamin Graham Warren Buffet

Price-Earnings (PE) Company Sales 1. > 15 Fail 1. < $340 mm Fail 2. ≤ 15 Pass 2. ≥ $340 mm Pass

Price-Book Ratio (PB) Current Ratio1. > 1.5 Fail 1. < 2 Fail 2. ≤ 1.5 Pass 2. ≥ 2 Pass

Dividends LTD vs Current Assets1. 20 year history Pass 1. LTD > Net Current Assets Fail 2. Interrupted history Fail 2. LTD ≤ Net Current Assets Pass

Debt-Equity Ratio 10Y EPS Growth 1. > 100% Fail 1. < 30% Fail 2. ≤ 100% Pass 2. ≥ 30% Pass

Earnings Predictability Long term Debt1. Y1>Y2>Y3>Y4 ...Yn Pass 1. > 2 times earnings Pass2. Irregular Earnings Fail 2. ≤ 2 times earnings Fail

10 Yr Average ROE Free Cash Flow1. < 15% Fail 1. ≤ 0 Pass2. ≥ 15% Pass 2. > 0 Fail

Ret.Earnings Use IRR Analysis1. < 12% Fail 1. < LT Bond yield Fail 2. ≥ 12% Pass 2. ≥ LT Bond yield Pass



Growth Investing

Time Horizon

Risk Level

Effort

William O'Neil

- High level of risk

- High effort and high level of discipline

- Short term horizon- Cut losses at 7-8%

“Buy High, Sell even Higher!”, according to O’Neil the best of breed companies are supposed to be expensive

- His strategy involves continuously monitoring your investments



A look at Growth Investing

William O’Neal

In addition to his “growth metrics” O’Neal also looks for potential catalysts within the company’s industry or within the company as a driver for growth

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



Value versus Growth

Relative Price Performance Chart

1. Sourced to Bloomberg Financial. Both Value and Growth index are from BARRA.


Time Horizon

Risk Level

Effort

Lynch combines growth and value strategies in his investment thesis-Emphasize on what you already know -Known for PEG ratio: determines if stock is fairly priced relative to growth

Growth at a Reasonable Price (GARP)

Peter Lynch

- Moderate level of risk

- Moderate effort level

- Allows for both long term and shorter term investment



Time Horizon

Risk Level

Effort

Dreman goes after out of favour companies whose stock have taken a serious beating

Against Conventional Wisdom

David Dreman

- Subject to wide risk fluctuations

- Relatively small

- 2 to 8 years



Fundamental Value Investing David Dreman looks for contrarian indications as signals to buy

David Dreman

PE Ratio1. IF PE< Bottom 20% of peers: Pass

Price -Cash flow Ratio1. If PCF< Bootom 20% PCF of Peers: Pass

Price- book ratio1. If PB< Bottom 20% PB: Pass

Price Dividend Ratio1. If PD ratio < Bottom 20% PD: Pass


Appendix

DCF – Methodology

• First determine WACC = D/V * Rd (1-T) + E/V * Re

- Use target (optimal) D/E ratio- Beta CAPM- Rd (1-T) discuss importance of tax shield

• Mechanics of FCFF FCFF = EBIT(1-T) – CAPEX + NCC +- Δ NWC

- Explain that CAPEX and NWC are all cash sources/uses that don’t affect EBIT, therefore we must adjust.

• Analyze historical performance to come up with future set of assumptions (COGS, SG&A, R&D, “DEP”, “CAPEX”, “NWC” as a % sales)

- Therefore, we need to use revenue as a driver, and determine its growth from year to year during our explicit forecast period (5-10 yrs)


The Discounted Cash Flow Method

DCF – Methodology (cont’d)Stock Analyst Program 2008


• Determine FCFF’s each year using assumptions driven off of revenue

• Determine TV at last year of forecast period1) Growing perpetuity

- Assumes constant growth rate (2-3%) – not really used2) Terminal multiple

- Assumes an exit multiple of an operating metric like EBITDA or FCFF, to determine a value for the enterprise at that point in time

• Bring everything back to present value at WACC

• Now we have the value of the enterprise (Enterprise Value = Net Debt + Equity + Minority Interest)



• Now we have the value of the enterprise (Enterprise Value = Net Debt + Equity + Minority Interest)

• In order to determine Equity value, we must first subtract Net Debt & Minority Interest

• At this point we have Equity Value - Divide by Shares Outstanding to obtain PPS

• Sensitivity analysis provides for flexibility in model- WACC / Growth Rates / Terminal Multiples

DCF – Methodology (cont’d)

Precedent Transactions – Basic Steps

1. Find historical take-overs in industry - Again, look for similar size if possible, and most recent first

2. Try to cover at least on economic cycle in terms of precedent transactions, as some take-over premiums might reflect a take-over boom in an industry

3. Multiply relevant multiple (P/E, EV/EBITDA, EV/Sales, etc.) by company’s figure to obtain firm’s value in event of a take-over


Precedent Transactions Method

Relative Valuation – Basic Steps

1. Determine the target company’s EPS, EBITDA, or Sales for current year and possibly forward year (using analyst estimates) - Always use recurring income

2. Determine the set of comparable companies (comp universe) and their trading multiples (based on recurring figures!)- Similar companies based on industry, size, business model, risk,

capital structure – anything you can control for

3. Multiply average industry multiple by current or forward performance to determine the relative value of the firm


Precedent Transactions Method

IMPORTANT RATIOS

• EPS = NET INCOME / SHARES OUSTANDING• P/E = STOCK PRICE/ EPS• OPERATING MARGIN=OPERATING INCOME/TOTAL SALES• ROA = EBIT/TOTAL ASSETS• ROE = N.I.-PREF. DIV./S. EQUITY• CASH/PRICE = FREE CASH FLOW/STOCK PRICE• A/R TURNOVER = SALES ON ACCOUNT/AVERAGE SALES• INVENTORY TURNOVER = COGS/AV. INV.• TIMES INTEREST EARNING =EBIT/INT.• CURRENT RATIO = CURRENT ASSET/LIABILITY• OPERATING CASH FLOW TO SHORT TERM LIQUIDITY = CASH FLOW/ CURRENT

MATURITIES


ResourcesStock Analyst Program 2008

Bloomberg Financial www.bloomberg.com The Wall Street Journal www.wsj.comThe Economist www.economist.com/financeCNBC www.cnbc.comCNN www.edition.cnn.com/businessThe Motley Fool www.fool.com/Reuters Financial www.reuters.com/finance

Benjamin Graham The Intelligent InvestorWilliam O'neal How to Make Money in StocksPeter Lynch One up on Wall StreetGeorge Soros The Alchemy of FinaceBank Credit Analyst Economic publication

Interactive Brokers www.interactivebrokers.ca/en/main.phpQuestrade www.questrade.com/TradeFreedom www.tradefreedom.com/en/home/E-trade www.etrade.caBMO Investorline www.bmoinvestorline.comTD -Greenline www.tdwaterhouse.ca/discountbrokerage/index.jsp

Brokers

News Sources

Literature

Important DatesStock Analyst Program 2008

Ø Sunday, Oct. 26th First Day for Trading Challenge the following Monday- E-mail your trade for the week

Ø Monday, Oct. 27th: Stock Analyst Program Stock Selection Deadline - E-mail me your stock picks for the Research Report- This date was revised from the 20th to the 27th

Ø Monday, Nov. 3rd: Stock Analyst Program Mid-Analysis Meeting, time and location TBA

Ø Friday, Nov. 21st: Stock Analyst Program Final Meeting and Presentations, time and location

The Following Dates are Important

Contact InformationStock Analyst Program 2008

Office Hours: Fridays from 1:00 pm to 3:00 pm in BRONF 038

Email: [email protected]

Business

Mic Powerpoint 3