Hedge Fund Investment Thesis: The Industry Model January, 2016
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Introduction 4 Started on Wall Street in 1999 at a bulge bracket Investment Bank Ended career as a Managing Director at a NY bulge bracket, managing a team of people, running one of their institutional sales businesses Since 2014 I have been managing money for a billionaire across bonds and equities.
Core parts of a Stock Thesis 5 This session is going to continue on with some of the ideas we discussed in the last presentation. The core idea is to teach you how to analyze a business.
Investigating an idea 6 How do we develop an idea? As a reminder, we use progressive filters Industry model - how does the industry? Business model - how does the business model work? Financial model - what do their finances look like? Valuation model - can you value the company, is it cheap?
What makes a business great? 7 This session is going to cover what a good business looks like and how to understand the industries that they may belong to Think in your minds about what a good business to own would be : What characteristics would it have? What industry would it be in? What would the company do?
8 "If you don't know where you are going, you will wind up somewhere else." YOGI BERRA Investing is about first understanding the kind of business you want to own, than searching madly for something that looks like that.
My opinions on a good business 9 This is what I think a business should look like: Produce a lot of cashflow Not require a lot of investment Be stable and not sensitive to external factors Should be hard to displace / strong moat Create value for its customers Video to watch: https://youtu.be/t-swuue3sms
My opinions on a good business 10 Why does cashflow matter? Because if a business produces no cashflow, then it has no value If it produces a lot of cashflow and can continue to, then its great Why is capex bad? Because capex / investment takes away from your cashflow If you need to keep re-investing, then what do you keep?
My opinions on a good business 11 Why care about external factors? If your cashflows are impacted by commodity prices or interest rates, then you are not in control of your destiny Need to discount cashflows harder What is a moat? A moat is something that protects your business from harm Prevents your industry and business from disruption Think about some businesses that have disappeared in the last five years
My opinions on a good business 12 Create value for its customers In the long run if your customers don t benefit from using you and don t like using you, then your business is at risk Your customers are the ones paying your bills Your customers drive all cashflow A business with unhappy customers will have long term problems But happy customers doesn t necessarily mean good business!
An example of a good business 13
An example of a good business 14
How do you actually understand a business 15 Of course read all the annual reports, but then do some SCUTTLEBUTT What does that mean? Talk to customers Talk to suppliers Talk to current employees / ex-employees Talk to other shareholders Talk to competition Read this: http://tinyurl.com/j54h7kd
Industry Structure - Part 1 16 Lets walk through how you could understand an industry All companies exist within an ecosystem, an industry Understand how an industry functions, and what changes are happening in the industry Companies are not steady state and industries are not steady state Capitalism creates change, change creates instability Change can be value destructive to businesses and stocks
Industry Structure - Part 2 17 A bad industry can still have good businesses But good industries can also have very bad businesses For example, in technology you can have commoditized parts suppliers. That's a bad business Or you can have a high margin vertically integrated player like an Apple They are both impacted by similar industry level forces though
Industry Structure - Part 3 18 In technology, lets brain storm some industry level forces that matter 1. Global GDP growth 2. Corporate spending / IT spending 3. Consumer spending 4. Technological change
Industry Structure - Part 4 19 In technology, drilling further 1. Product launches 2. Global tax regime 3. M&A & consolidation opportunities
Industry Structure - Part 4 20 Industry structure is key, questions to ask yourself : Do you want to be closer to the end market / consumer? Do you want a market with many buyers or a few? Do you want a market with many suppliers or a few? Do you want a market with many products or a few? Do you want a market with many competitors or a few?
Industry Financials - Part 1 21 Most financials are very complex, think about how you can simplify them All industries are different, while everyone may follow US GAAP, the accounting specifics for each industry are different Before you proceed make sure you understand industry specifics and what is important in each industry You must know a little accounting if you are going to be a hedge fund analyst
Industry Financials - Part 2 22 For example: When looking at banks: What is happening to book value What is happening to loan impairment What is happening to loan loss reserves When looking at a software company: What is happening to top line growth What is happening to operating margins What is happening to free cash flow
Industry Financials - Part 3 23 Things I do when I am looking at a company's financials : Look at the competition - do they treat things the same way? Find an accountant and talk to him - make friends at an accounting firm Read the foot notes Ask yourself if you think this is correct, or could they be hiding something If you aren't sure, find someone who knows the sector better Don t trust the numbers and don t trust management
Bonus Materials Macro forces 24 If you want to understand all the headlines and learn from the richest hedge fund manager in the world, then watch this: https://youtu.be/phe0bxaiuk0
25 Next episode In the next episode, we will deep dive into the business model and then combine it with the industry model