Introduction
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Introduction
• Seven years ago Gary Rolle of
Transamerica donated $200,000 to
establish the CU Student Investment
Fund.
– This fund has since grown (and shrunk) to
over $270,000
– This is in spite of our scholarship program
• We donate up to 4.5% of the fund to scholarships
– This year, you will be managing the fund.
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Job Stuff
• Send the latest so that we can make a
resume book
– PDF format is best
• Students have obtained jobs directly and
indirectly as a result of this course
• Mary Banks will talk to class
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Purpose of the Course
• Understand the investment management
profession.
– This profession is a blend of
• theory
• practice
• To construct our portfolio we will apply the
basic principles of
– security analysis, valuation, asset pricing
theory, portfolio construction and portfolio
performance evaluation.
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Learning Objectives - Quantitative
This is an applied course. The idea is to apply what you learned in previous
courses.
1.
Stat 1 is useful.
1.
2.
2.
Valuation is a noisy process.
1.
2.
3.
4.
3.
Growth projections, discount rates, costs of capital are estimated.
Accounting data has numerous non-persistent items.
This has consequences for the (lack of) precision of valuation.
Sensitivity analysis is important.
What you learned about asset pricing is misleading.
1.
2.
3.
4.
5.
Arithmetic and geometric means are different and it matters.
Skewness matters
Diversification is important but don’t use the textbook methodology to do
asset allocation.
The mean isn’t whet you’re likely to receive, even if it’s what you expect to
receive.
The asset pricing models you know don’t work.
You can evaluate portfolio performance – sort of.
Introduction to institutional investment management
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Learning Objectives - Qualitative
1.
When you’re valuing a company, it helps to
1.
2.
Know what the company does.
Understand the competitive environment and your company’s
place in that environment.
Understand growth prospects for the industry.
Understand what makes your firm special.
3.
4.
2.
You will hone your presentation skills
1.
2.
3.
By giving an industry overview (a group project for some)
Giving a stock presentation (an individual project)
By answering questions from an adversarial audience (during
your presentations)
•
and you are that audience.
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Activities outside class
• Burridge Center Conference 11/209
– Two of you may present.
• This can be a valuable experience not only in
terms of education, but also in terms of future job
prospects.
• CU Investment Committee Meeting
– If we are lucky.
• CU Investment Banking Forum
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Prerequisites
• FNCE 3010, 3020
• Accounting experience preferred but not
strictly necessary
• Working knowledge of statistics essential
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Materials
•
•
•
•
Damodaran, Damodaran on Valuation.
Swensen, Pioneering Portfolio Management
Lowenstein, When Genius Failed.
HBS case 9-103-015, United Parcel Service’s
IPO.
• Various articles
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Course Policies
• Lecture slides will be available on the
website in advance.
• YOU MUST READ STUDENT
PRESENTATIONS IN ADVANCE.
• STUDENT PRESNTATIONS MUST BE
AVAILABLE AT LEAST THREE DAYS IN
ADVANCE (email ok).
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Absences
• We recognize that you are good students.
This means that you will be gone for job
interviews.
– Let me know in advance!
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Grading
• The final grade for the course will be
determined from the following:
–
–
–
–
Initial presentation (there is a group component.
Final presentation
Other assignments and class participation
Final exam:
15%
35%
30%
20%
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The portfolio
• The class has roughly $270,000 to invest
• We now divide the class into groups.
– Each group will analyze a different sector.
– One sector has been chosen for us: the “Socially Responsible
Investments” sector. Also, “Colorado companies”
– Each group will be the “analyst” for the sector and will be the
lead analyst for a particular stock in the sector.
– Investments are equity of relatively large capitalization
companies, above $1 billion and monthly volume of at least $.3B
– The CU Foundation won’t allow short-selling or margin accts.
– Each group should put down its top 3 choices for sectors.
• The choices:
• S&P companies and sectors are available on the website.
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The Sectors – Choose Groups
• Energy
– Exxon
• Materials
– Alcoa
• Industrials
– 3M
• Consumer Discretionary
– Maytag
• Consumer Staples
– Kraft, Altria, Coke
• health care
– Merck, Amgen, US healthcare
• Utilities
– Duke Energy
• financials
– Citigroup, Met Life,
American Express, Capital
One
• Information technology
– Microsoft, Cisco, IBM,
Applied materials
• Telecoms (but there are
so few…)
– Verizon, Lucent
• Socially responsible
companies
– Criteria for you to set
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The first 4 Weeks
• Devoted to security analysis
– statistics
– Accounting
– Modeling
– valuation
• At the end, to help your presentations
– case
– examples of practitioner security reports
– examples of student reports
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Investment week – 2/10,2/12
• Each group will provide a 15 minute sector
analysis including a brief introduction to selected
securities.
• For the sector analysis
– Competitive structure of the sector and/or industry.
– The growth and value characteristics of the industry
– Cyclicality of the industry
• Where are we in the cycle?
• Interest rate sensitivity
• Technological obsolescence risk
• Each individual will be responsible for:
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Investment week – 2/10,2/12
• Each individual will be responsible for
–
–
–
–
–
The investment thesis
A very brief summary of the business
A valuation analysis (or at least chosen metrics)
A brief analysis of competitors
Key risks associated with the sector and the stock
• Your sector analysis may or may not be done
jointly with the other person in your group.
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Group Presentations after
investment week
• In each class, one or two groups will pitch
his/her stock for fifteen minutes.
• Then, there will be questions from the
audience.
• A group will be selected at random to lead
the discussion and critique the
presentation.
• The presenting student will essentially
write a research case for the stock.
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Individual Presentations after
investment week
• In addition to fleshing out the details in the initial
presentation (the five items immediately above),
the student will analyze:
– The competitive environment
– Any competitive advantages the firm might have
– Growth prospects
• If the firm has multiple business units, these are best
analyzed separately.
– Determinants of the firm’s return on capital
– How was the stock affected by what you considered
to be the key risks.
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Individual Presentations after
investment week
• At least 3 days prior to your presentation, you will
distribute your report summarizing the research case for
the stock along with attached financial statements,
including the statement of cash flows.
– You can do this by e-mail via the list that we will make on the
first day.
– This will provide the basis for class discussion during your
presentation.
• The idea is to provide the student with the flavor of
pitching a stock when working for a money management
firm.
• Note that this is not a class in trading, but we will
reexamine the portfolio in the event of big moves.
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Data Issues
• Where to get data
– Wrds Account: at wrds.wharton.upenn.edu
• Account:
TBA
• Password: TBA
• You can get past returns, analyst forecasts, etc.
– Research Insight
– Other data sources
• Look at Damodaran’s website which is
– http://pages.stern.nyu.edu/~adamodar/
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Lectures after investment week
• Portfolio theory and asset allocation.
– Implications of diversification, both cross-sectionally
and intertemporally.
– Review of various asset classes
– Asset pricing models, such as the CAPM, APT, and
ad-hoc factor models.
– Basics of portfolio performance evaluation: Sharpe
Ratios and various alphas.
– LTCM
– Statistical difficulties associated with performance
evaluation, and why it is difficult quantitatively to
determine if a particular money manager’s superior
performance is likely to continue.
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Introduction to Valuation
• Goal: To decide which assets to include in
our portfolio.
– One strategy would be to buy undervalued
assets.
– To determine whether assets are
undervalued, one needs a method for
estimating what they are worth.
– Hence, valuation.
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The Role of the Analyst
• In this class, YOU are security analysts.
• You need to investigate a business to see
if money can be made buying its stock.
– Must collect important facts about the
business and its competition.
– Must identify key investment controversies.
– Must try to identify gaps between intrinsic
value and market price.
• And see if perhaps there’s a better deal nearby.
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Qualitative and Quantitaive
Aspects to Valuation
• When using quantitative analysis, it’s very
important to understand where your numbers
come from and what they mean.
– Inadequate or incorrect data is an obstacle.
• To understand when data is inadequate or incorrect, you
must have a knowledge of both
– Accounting
– Statistics
• Confidence about the numbers is essential for
valuation.
– You MUST understand both the benefits and the
limitations of the quantitative approach.
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Valuation Approaches
• One approach: DCF analysis
– Estimates cash flows from the firm each period and
discounts these cash flows at the appropriate risk
adjusted rate.
– How would you make this concept operational at the
firm level?
• The results may be less than satisfactory.
–
–
–
–
A problem is that valuing a firm in isolation is hard.
Dealing with estimation error is hard.
What about multiple stages?
What can be easier is to value a firm relative to other firms,
which is why people use multiples analysis.
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Multiples and real options
• Multiples
– In the cross section: find a comparable firm and compare, e.g.,
price earnings ratios and buy the cheaper one. Unfortunately, it
is hard to find a “comparable firm.”
– One could also compare with a broad market index.
– But there are pitfalls to this approach too. For instance?
– In the time series: Determine if the asset is undervalued relative
to itself or a reference portfolio at different times. If so, buy.
• The problem here is that “undervalued” things may stay that way.
• A third way: contingent claims analysis, which is
appropriate if firms possess a lot of real options.
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Our application
• In this part of the course, what we will do
is examine these valuation strategies in
turn and apply them to the problem of
portfolio selection.
– Your initial stock picks will be in part based on
these methods of analysis.
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What Fundamental Analysis Does
• Estimates the value of a firm from
fundamentals
– Expected cash flows, including growth
prospects, real options, etc.
– Evaluates the risk profile of the firm (which is
what is used to discount the cash flows.
• Neither of these things is particularly easy
to measure, particularly out in the far
future.
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Why Fundamental Analysis is Hard
• You need to estimate future cash flows
somehow. Possible inputs:
– Analyst forecasts (others’ analysis)
– Your own forecasts (which can include information
based on analyst forecasts).
• You can use past data to estimate a statistical model.
– This can be misleading for multiple reasons. Why?
• You can augment that by using your knowledge of the firm’s
future prospects. This is just plain hard. We’ll look at the
forecasting skills of real analysts later on.
• And you need to discount them. That means
you need a cost of capital.
– Where to get that?
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