Security Analysis
Fall 2013
GUY SHANON
Professor Office Location: Kingstown Capital Management
Office Phone:
Fax:
212-854-1933 (Heilbrunn Center)
212-851-9509 (Heilbrunn Center)
E-mail: guy@kingstowncapital.com
Class location: Kingstown Capital Management (100 Park Avenue, 21st Floor)
TA:
REQUIRED COURSE MATERIAL
These books should be read in their entirety before the first day of class. This syllabus is being distributed in late June to
allow you to have time to get this reading done. Be sure to start early.
Security Analysis (Sixth Edition), Benjamin Graham and David Dodd*
Value Investing From Graham to Buffett and Beyond, Bruce Greenwald, Judd Kahn, Paul Sonkin, Michael van Biema,
The Little Book That Beats the Market, Joel Greenblatt
Common Stocks Uncommon Profits, Kenneth Fisher
*Security Analysis can be a bit tough to get through. Focus on the main sections and pace yourself – it’s hard to read
this book quickly.
Recommended Reading
Distressed Debt Analysis, Stephen Moyer
Fooled By Randomness, Nicholas Taleb
Distress Investing: Principals & Techniques, Martin Whitman
Analysis for Financial Management, Robert Higgins
REQUIRED PREREQUISITES AND CONNECTION TO THE CORE
Prerequisite: Capital Markets
The learning in this course will utilize, build on and extend concepts covered in the following core courses:
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Core Course
Corporate Finance
Connection with Core
1. Cost of Capital
2. Valuation
3. Financing Options
4. Time value of money
5. Opportunity cost (of capital)
6. The Capital Asset Pricing Model (CAPM)
7. Firm Valuation Model
Financial Accounting
1. The “accounting equation”
2. Revenue and expense recognition
3. Resources and obligations – measurement and disclosure
Global Economic
1. Risk Management
Environment
2. What is Gross Domestic Product and how is it measured?
3. What causes inflation?
4. What causes changes in exchange rates?
5. What are the causes of business cycles?
6. What are the effects of monetary policy?
7. What are the effects of fiscal policy?
8. What is the role of financial markets in the economy?
Managerial Economics
1. Barriers to entry
2. Moats
3. Maximization and thinking on the margin
4. Analyzing complex decision-making under uncertainty
5. Decision-based cost analysis
6. Pricing with market power
7. Market segmentation and other advanced pricing strategies
8. Understanding market competition and equilibrium thinking (in the
short-run)
9. Market equilibrium thinking (in the long-run) and barriers to entry
10. Strategic interaction among firms and Nash equilibrium
Strategy Formulation
1. Trade-offs, value-added, efficiencies
2. Creation of value vs. value capture
3. Competing firms
4. Co-optition and Complementors
5. Strategic interaction analysis
6. Diversification and scope
7. Ethics & IBS
8. Behavioral and evidence-based strategy
9. Management
Students will be expected to have mastered these concepts and be able to apply them in the course.
COURSE DESCRIPTION
“An Investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory
return. Operations not meeting these requirements are speculative.” – Security Analysis, Graham and Dodd
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This course will use the sixth edition of Graham and Dodd’s Security Analysis as a framework for building up to a full
appreciation of what the authors meant by this statement and ultimately a road map for a successful investing
approach. We will explore:
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Financial Statement Analysis
Valuation Methodologies
Primary Research
Behavioral Aspects of Investors and Security Markets
Tips and Tools for The Research Process and “Pitching” Skills
Consistent with the approach taken in Security Analysis, this course will examine both stocks and bonds, but will focus
mostly on stocks.
The above-mentioned areas will be addressed through a combination of short lectures that incorporate sections from
Security Analysis, brief and full-blown case studies of companies to bring real-world meaning to the lecture concepts,
guest lecturers, and group and individual assignments. Specifically, homework will be comprised of:
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Examples of companies and their financials (both dated and live) to reinforce concepts discussed in lecture for
that week
Two company case studies that are more fully developed than the above. These will comprise two class sessions
towards the end of the course
A final group project that students will begin to work on at the midpoint of the course, culminating in a
presentation to the class at the end of the course
COURSE OBJECTIVES
This objective of this course is to introduce students to the field of security analysis and the kinds of things analysts
consider and struggle with on a day-to-day basis. Successful investing is a lifetime pursuit that involves a commitment to
constant learning and skills development. A good security analyst's investing approach is always being improved
through on-the-job successes and failures and refinement of the investing process. This course is intended only as a
starting off point for that journey – the rest is up to you.
ASSIGNMENTS
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Short homework assignment based on lecture
Final Group Project
CLASSES 1&2 (September 3, September 10)
Class Introduction
 History of value investing at CBS
 Guy Shanon/Kingstown backgrounds
 Introduction of students/what do students want to get out of the class?
 Class ground rules and expectations
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Review road map of the course
Market Efficiency and Value Investing – Backdrop For Security Analysis
 EMH
o The basics
o Are markets always efficient?
o Grossman-Stiglitz paradox
 Markowitz mean/variance optimization
 Value Investing
o Academic literature/empirical evidence
o Margin of safety/capital preservation
o Risk does not equal variance
o Value vs. glamour multiples
The Business Model
 How does this business make money/ what are the drivers?
 Break it down in simple terms, using common sense, then start asking questions
Business “Quality” – Some Introductory Thoughts
 What does this really mean to the security analyst?
 Quick basics on competitive advantages and ROIC
 The price/quality continuum
Screening For Ideas
 Using CapitalIQ, Bloomberg, other web-based resources
 Do’s/don’ts in screening
CLASS 3 – September 17
Valuation Basics
 Triangulation
o Public Comps
o Private Comps
o DCF
o What’s good and what’s useless about this
 Emphasis on Cash Flow
o Comparing cash flows from equities and bonds
o Approaches to calculating free cash flow
o Using EBITDA – Cap Ex as a yardstick
 Using Multiples Thoughtfully & Absolute Valuation
o The market multiple
o The Fed and Yardeni models
o What return would you need to own the business in its entirety and have it be your family’s sold
source of income?
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o Justified multiples based on cash flow risk and growth
o Operating income and cap rates
o Which cash flow stream are we capitalizing?
 What Does Risk-Adjusted Return Mean?
 Return on Invested Capital
How To Work On An Idea
 Be ruthless about your Return On Time
 Keep narrowing the issues
 Consensus vs. variant view
 SEC documents
 IR calls
 Staying organized and documentation
 Scuttlebutt research
 An investment memo example
o Examples of good ones/templates
CLASS 4 – September 24
The Primacy of The Balance Sheet
 What does it tell us & why is it so important?
o Book value, tangible book value
o Retained earnings
o Financial leverage
 Common analytical areas, e.g.,
o Inventory LIFO/FIFO
o Deferred revenue
o Pension accounting
o PP&E Cost vs. market
o Deferred tax assets and liabilities
o Working capital analysis
o Intangible assets
o Read the footnotes…
 Liquidation Analysis
 Capitalization
o Building the cap table used in distressed debt analysis
 Book value multiples revisited
CLASS 5 – October 1
The Income Statement
 Accrual vs. cash accounting
 EPS vs. cash earnings/quality of earnings
 Margins
 Accounting for minority interests
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The Cash Flow Statement
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Breaking down the components
Common sources of confusion
CLASS 6 – October 8
Behavioral Finance
 Traditional vs. behavioral finance
o Rational utility maximizer vs. Satisficer
o Risk aversion vs. loss aversion
 Common Behavioral/Cognitive Biases
o Anchoring and framing bias
o Recency bias
o Confirmation bias
o Herding
o Institutional biases on Wall Street
o Agency biases
 Applying These Concepts As A Security Analyst
Class 7 –October 22
Competitive Advantages
 Greenwaldian vs. Porter’s Five Forces
 Business “Quality” Considerations Revisited
Evaluating Management
Class 8 – October 29
Primary Research
 What to focus on
 How to obtain and organize information
 Separating the signal from the noise
Class 9 – November 12
Pitching Skills
 What makes a successful pitch?
o Key components
o Tips for keeping it short and impactful
o Coping with questions and interruptions
Class 10 – November 19
Case Study #1
Class 11 – November 26
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Case Study #2
Class 12 – December 3
Final Project Pitches
METHOD OF EVALUATION
Class Participation
25%
Homework Assignments
Final Group Project
25%
50%
Grades will reflect knowledge and application of the course material and communication skills. This course is intended
to be interactive and class participation will be crucial to the success of this class.
CLASSROOM NORMS AND EXPECTATIONS
This course is being taught at the offices of Kingstown Capital, 100 Park Avenue (@ 40th Street). Class begins promptly
at 2:15pm. Trains are often late, midtown is usually congested, rain and snow slow everything down – these are all
things you should consider in building a margin of safety into the amount of time you budget to get to the office from
campus. Anyone not in the conference room 5 minutes after the class start time will not be admitted.
Each week one student will act as class secretary. Duties include taking assiduous notes during class, cleaning them up
shortly thereafter and then distributing to the class, and also coordinating submission of homework assignments via
email to the teaching assistant and professor.
Any type of recording of the class is absolutely NOT permitted without prior approval.
If you are going to miss a class you must provide notice in advance.
This will be a small class of 13 students – every person counts, and there are no free riders. Students are expected to
come to class prepared and ready to field cold-call questions.
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