Security Analysis
Columbia Business School Spring 2014
Prof. Ian McDonald and Prof. Ryan Brown
Introduction and Overview
Ian McDonald, CFA – Ian has been an analyst and PM for 16 years. He is currently Managing
Director at Hilltop Park Associates, a NYC-based hedge fund, and Portfolio Manager of the
Midships Opportunity Fund. Prior to Hilltop Park, Ian co-founded Tourmalet Advisors, a $750M
multi-asset firm and served as President and Director of Research, overseeing a team of
analysts for the firm’s global long/short equity fund and co-managing a series of distressed
residential mortgage funds. Prior to Tourmalet, Ian was a Principal at Pequot Capital
Management. As a generalist, he covered a variety of industries and recommended
investments across the capital structure for the firm’s flagship Partner’s Fund. Ian also served
as Pequot’s Head of Mortgage Strategies. He joined Pequot in 2003 from sell-side investment
boutique Fox-Pitt, Kelton, where he worked in the coverage of the specialty finance industry.
Ian is an adjunct professor at Columbia Business School and CFA charter holder. He graduated
from the US Merchant Marine Academy with a B.A. in Marine Transportation and NYU’s Stern
School of Business with an MBA in Finance and Accounting.
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Introduction and Overview
Ryan Brown – Ryan Brown is a generalist analyst and Co-Portfolio Manager of Davis Select
Opportunity Fund at Davis Selected Advisers in New York City, a privately-held, large cap, longduration fundamental value manager overseeing approximately $45bn of equity AUM. Ryan
has 16 years of investing experience. Prior to joining Davis in 2009, Ryan Brown worked for
Quadrangle Group where, in 2005, he was a co-founding member of Harpoon Equity
Management, a $500mn global communications/consumer-focused hedge fund. Mr. Brown
has also held senior equity research roles within Merrill Lynch’s Institutional Investor #1-ranked
Media & Entertainment and Satellite Communications teams. Mr. Brown started his career
with Merrill Lynch’s equity capital markets group.
Ryan is an adjunct professor at Columbia Business School and CFA charter holder. He received
his B.S. from the University of Florida.
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Deliverables – IM & RB
Security Analysis
The course is designed to provide the student a practical overview of evaluating a company and
valuing its securities with the goal of becoming a more proficient and balanced investment
practitioner, whether as a principal or an agent.
• We believe all sustainable investing
philosophies are sub-sets of the Value school
founded by Benjamin Graham
• In a series of lectures, we will present
the key principles in our investment
philosophy. The goal is a clear
understanding of how we approach:
• Value investing
• Security analysis
• Critical thinking
• This will follow with a comprehensive review
of our investing process, or the method by
which we execute on our philosophy
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• Review case studies and provide practical examples,
including a wide range of situations we have been involved in
• Work through a process flow chart - a template
detailing search strategy, diligence, valuation, and
capital allocation
• Formulate an investing checklist to avoid errors of
omission
• Explore the art of a stock pitch – how to select,
research, and present a equity investment
• Study readings, quotes, interviews, and lectures from world
class investors
• Acquire a broad knowledge of the best investors and
their brand, philosophy, and key insights
• Offer a series of guest lectures from practicing
professionals
• Study industry profit pools and individual business models
• Holistic view of the S&P 500 sectors so as to be
conversive on pros and cons
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Deliverables – Class
Required
Attendance and participation
Reading assignments
“The Most Important Thing: Uncommon Sense for the Thoughtful Investor”, Howard Marks
2 or 3 homework assignments, each a 30 minute time commitment
Basic Company Report
- Teams of 3
- Companies and/or Industry assigned
One Page Hypothesis
Present investment recommendation to class
Written report due last class, April 29th
Max 5 pages excluding charts/exhibits
Optional:
Office Hrs with Ian and/or Ryan
Either dry run on class presentation or another security altogether
Course Structure
- 55% Lecture IM & RB
- 30% Guest Lecture
- 15% Class Presentations/Interaction
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Outline
Spring Security Analysis 2014
1
Intro, Philosophy, Process, Market Efficiency
2
Intrinsic Value, Compound Interest, Price vs Value
3
Margin of Safety, Competitive Advantage Period, Owner Earnings
4
Circle of Competence, Descriptions, Process
5
Business Models, Great Businesses
6
Moat, Ecosystem; Guest Speaker
7
Spring Break
8
Pricing Power
9
Pricing Power 2; Guest Speaker
10
Mgmt, Incentives, Capital Allocation; Guest Speaker
11
Seasoning, Mistakes; Class Presentations
12
Art of Presenting an Idea; Class Presentations
13
Class Presentations
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Our Philosophy
“What have been the keys to your success?” My answer is simple: an effective investment philosophy, developed
and honed over more than four decades and implemented conscientiously by highly skilled individuals who share
culture and values.
- Howard Marks, Oaktree Capital Management
•
All sustainably successful investing philosophies are sub-sets of the Value school founded by Benjamin
Graham.
– Market prices often fail to reflect intrinsic values, defined as liquidation value or long-term, cashgenerating potential.
– Behavioral biases cause security mispricing and sub-optimal decision making.
•
Stocks are ownership interests in real businesses, not pieces of paper to be sold to a “greater fool.”
– Purchases should be evaluated as if an investor were buying the entire business.
– Equity investors are responsible for the entire capital structure. We must think like creditors first,
owners second.
– Over long periods of time management’s reinvestment of cash flows has a significant impact on
outcomes.
– Duration matters and moats can be filled in.
•
Value is the NPV of future free cash flow.
– Cash economics drive long-term shareholder returns.
•
Risk is the probability of permanent capital impairment through overpayment, catastrophic dilution, or
inattention to return distributions.
•
Incentives matter.
– Involved owners act differently than managers with asymmetric payoffs.
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Superinvestors of Graham-and-Doddsville
The minute you get away from the fundamentals – whether it’s proper technique, work ethic, or mental
preparation – the bottom can fall out of your game, your schoolwork, your job, whatever you’re doing.
-Michael Jordan
Margin of
Safety
Mr.
Market
Moat
Management
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Investment Process
Such a system will pay off ultimately, regardless of when it is begun, provided that it is adhered to conscientiously
and courageously under all market conditions.
- Ben Graham
Populate and expand idea
warehouse
•Add and maintain
companies in warehouse by
analyzing fundamentals
through:
• Management meetings
• Filings
• Competitive analysis
• Case studies
• Sell-side resources.
Scenario Analysis
• Construct best-, base-, and
worst-case scenarios to
calculate probabilityweighted expected value.
• Analyze
industry return
distributions to capture
realistic assessments of
best- and worst-case
scenarios.
Pre-Mortem
• Analyze before investing
what can go wrong:
• How does a company blow
up?
• What are the best
arguments against our
investment hypothesis?
• How do we answer those?
Focus on:
• Size and growth of
available market
• Profit pool analysis
• Corporate strategy
• Management incentives
• Capital structure
• Capital allocation
• Regulatory & legal risk
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Investment Process
Written Reports
• To guard against drift,
document:
• Research findings
• Valuation approach
• Investment hypothesis
Custom Valuations
• Construct custom models
for each investment to
arrive at a cash-flow based
valuation of the company
and its securities,
integrating:
• All three financial
statements
• Unit disclosures
• Industry data
• We augment this using:
• Private market valuations
• Historical multiples
• Valuation analyses of
comparable companies
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Select Securities and
Sectors
• Greatest expected riskadjusted return, based on:
• Market valuation
• Credit spreads
• Volatility
• Alternative opportunities
Emphasize sectors with
most individual
opportunities combined
with:
• Cyclical analysis
• Secular trends
• Fundamentals
• Macro conditions
• Balance exposure via
fundamental drivers,
market behavior.
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