Stock Pitch Bootcamp for Beginners Doc 1

Stock Pitch

1. Stock Pitch Boot Camp – Week II
Investment Management Group
Chicago GSB
Fall 2006

2. Stock Pitch Steps:
1.Screen for investments (bottom-up / top-down)
2.Evaluate industry dynamics and company strategy
3.Forecast financials based on your strategic analysis
4.Determine value based on applicable methodologies:
Comparable valuation multiples (“Comps”)
Discounted cash flows (“DCF”)
Other (Abnormal ROE, Leveraged buyouts,
Transaction Comps, etc.)
5.Finalize Stock Pitch
Overview

3. Forecasting – Income Statement
Always anchor to reality
–Is the growth rate reasonable: anchor to industry
size, market share, populations, GDP, etc.
–Do the margins make sense: anchor to current and
expected competition, five forces, etc.
Line Forecast
Items Basic Detailed Source
Sales% growth Revenue drivers Strat. Analysis
COGS % of salesRevenue drivers Strat. Analysis
D&A % of COGSPP&E and intangiblesStrat. Analysis & Fins.
SG&A % of salesHeadcount, offices, etc.Strat. Analysis
Other% of salesDig into details Financials
Interest% interest% interest Financials
Taxes% tax rateTax rate Financials

4. Forecasting – Balance Sheet
Can the assets support the operations (e.g., sales/assets)?
Is there acceptable debt coverage (e.g., EBITDA/Int.)?
Don’t forget – it must balance!
Line Forecast
Items Basic Detailed Source
AR Turnover Days Financials
Inv. Turnover Days Financials
Other Flat / % of salesDig into details Financials
PP&E % of sales Capex AssumptionsMgmt. / Analysts
IntangiblesFlat / % of salesDig into details Financials
Other Flat / % of salesDig into details Financials
AP Turnover Days Financials
LT Debt Debt ScheduleRevolver Mgmt. / Analysts

5. Forecasting – Cash Flow Statement
Make sure the changes in the balance sheet translated
correctly to the appropriate categories on the cash flow
statement
–Working capital on the balance sheet is reflected in
the operating cash flows
–Increases in the PP&E (capital expenditures) go to the
investing cash flows
–Changes to debt are reflected in the financing cash
flows

6. Net Debt
Minority
Interest
Preferred
Stock
Market
Value of
Equity
Equity and Enterprise Values
Enterprise Value (a.k.a Firm Value)Enterprise Value
– Debt
– Preferred
– Minority Interest
+ Excess Cash
= Equity Value

7. Valuation – Discounted Cash Flows
(“DCF”)
Why are DCF models so well known?
–Theoretically, they make sense: academics love this
stuff
Why the disconnect between theory and practice?
–Skeptics tend to dismiss DCF analysis because
flexibility can lead to abuse
•“You can get a DCF to say anything”
•However, DCFs are still applicable as long as the
outcomes are rooted in reasonable assumptions

8. Valuation – Discounted Cash Flows
(“DCF”)
Free cash flow is cash available to stakeholders after
reinvesting to maintain or expand the business
Two common measures of free cash flows
–Free cash flow to the firm: starts with tax-effected
EBIT and is used to calculated enterprise value
•Discount using WACC
–Free cash flow to equity holders: starts with net
income and is used to calculate equity value
•Discount using cost of equity

9. DCF Example
Historical Year Ending December 31, Projected Year Ending December 31, Terminal
2003 2004 2005 2006 2007 2008 2009 2010
Sales $36,697.0 $41,397.0 $51,408.0 $61,689.6 $75,261.3 $93,324.0 $117,588.3 $150,513.0
EBITDA 1,868.0 1,931.0 4,725.0 5,843.5 8,634.3 12,573.0 18,193.7 26,298.2
Less: Depreciation (858.0) (817.0) (1,271.0) (2,015.1) (2,458.5) (3,048.5) (3,841.1) (4,916.6)
Less: Amortization 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
EBIT 1,010.0 1,114.0 3,454.0 3,828.3 6,175.8 9,524.4 14,352.6 21,381.5
Less: Taxes @ 40.0% (404.0) (445.6) (1,381.6) (1,531.3) (2,470.3) (3,809.8) (5,741.0) (8,552.6)
Tax-effected EBIT 606.0 668.4 2,072.4 2,297.0 3,705.5 5,714.7 8,611.5 12,828.9
Plus: Depreciation 2,015.1 2,458.5 3,048.5 3,841.1 4,916.6
Plus: Amortization of Intangibles 0.0 0.0 0.0 0.0 0.0
Less: Capital Expenditures (1,869.9) (2,281.2) (2,828.7) (3,564.2) (4,562.2)
Less: Additions to Intangibles 0.0 0.0 0.0 0.0 0.0
Less: Changes in Working Capital (916.8) 369.8 390.0 1,565.1 1,992.7
Unlevered Free Cash Flow $1,525.5 $4,252.5 $6,324.5 $10,453.5 $15,176.1
Sales Growth 20.0% 22.0% 24.0% 26.0% 28.0%
EBIT Margin 6.2% 8.2% 10.2% 12.2% 14.2%
ROE 11.1% 15.1% 19.2% 23.1% 26.6%

10. Valuation – Comparables
Comps are based on valuations relative to similar firms
–Comparable firms may be in the same industry, in
similar stages of their life cycles, or have similar
capital and operating structures
How do you know which multiples to use?
–P/E: commonly used among most industries
–P/B: cyclicals or asset-driven firms
–EV/EBITDA: commonly used in transactions
–EV/Sales: early stage firms without profits
•Get some guidance by looking at how sell-side
analysts think about valuation
•Analysts typically focus on forward multiples
Also, compare your stock’s current multiple(s) to its
historical multiple(s)
Equity
Values
Enterprise
Values

11. Valuation – Comps Example
Comparable Cos Implied Total Implied
Trading Multiples Enterprise Value Net Equity Value
Long-Term
Multiple of Projected Fins.xLow High=Low High -Debt(a) =Low High
Revenue 54,612$ 0.5 0.6 $24,575$30,037 $3,000 $21,575$27,037
EBITDA 3,641$ 5.4 6.6 19,660 24,029 3,000 16,660 21,029
Net Income 1,785$ 12.0 15.0 -- -- -- 21,421 26,776
Book Value 16,263$ 1.0 1.2 -- -- -- 16,263 19,516
Average Implied Value $22,118$27,033 $18,980$23,589

12. Valuation – Don’t Forget Econ.
1.Industry lifecycles – growth rates should slow as firms
mature
2.Competitive pressures and fighting for PIE would likely
pressure margins in the long-term
3.Long-run economic profits should be close to zero in the
out years
–Sustainable competitive advantages can support
some degree of excess economic profits

13. Valuation – Depreciation, CapEx and W.C.
4.Working capital is not a permanent source of cash flows
5.In long-term, make sure depreciation and CapEx make
sense:
–Depreciation > CapEx = shrinking business and
impossible in perpetuity
–Depreciation < CapEx = expanding business and,
generally, only reasonable if provide excess
economic value into perpetuity
–Depreciation = CapEx = maintenance CapEx /
mature / steady-state

14. Valuation – Other Methods
Transaction multiples
–Prior transactions that have occurred in the
marketplace may also help triangulate on value
Abnormal ROE
There are others….
–We have highlighted only the most important
valuation methodologies

15. Finalizing Your Pitch
Once you have completed your analysis, it is helpful to
create a one-page write-up on the stock
–The IMG web site has a template that you should use
when pitching to the group
–Under “Career Information”, select “Qualitative Stock
Pitch Template”
This document should contain only the most important
strategic and financial points regarding your stock
You may display this during IMG pitches, but you will
not typically provide it to interviewers
IMG pitches should last 3 minutes,
followed by 5 minutes of Q&A