As 2019 comes to an end, I am wrapping up my fourth year of doing this and was reflecting on how much I’ve learned since I started. You see a lot of job-posts for funds usually looking for 5 years of experience, and I can see why now, I truly didn’t know shit when I started. I wanted to focus this post on a few key lessons that I’ve learned that are less specific to my individual situation so that others may get some value out of them. Before I get into it I’ll start with a disclaimer: On one of my other posts where I discussed asset pricing theory, one of the comments was that it wasn’t original. Yes, no shit, how often do you ever truly come up with an original idea or theory in finance? I’m not Eugene Fucking Fama here, I’m just a guy from a non-target, with no mentor, trying to figure this shit out on my own, and who reads a lot to accomplish that goal. There are a lot of ways to make money in markets and I am continuously looking for the most optimal path, which is far from straight and narrow. As I have traveled down this path, this forum has been a useful resource, especially early on. So my objective with these more educational posts is to share what I have learned and to try and write from the perspective of “what would have been most helpful to myself when I was starting out?” Some of these lessons overlap but all were turning points for me once I realized them.
Know whether you’re generating alpha or putting on beta
This is one that it took me a while to understand, and my work to create a risk-factor model for us and the research that went into it really helped drive this home for me. You only generate alpha if you have identified a genuine mispricing, a reasonable catalyst, and timeline for the mispricing to correct. In reality, this is very difficult to do. For it to be a real alpha generating opportunity, you have to first be correct in your estimates, be different than the consensus, then understand what the market is missing, figure out how the market will realize your estimates are more correct than what is priced, and figure out how long this will take to occur. This does not mean that you cannot outperform without assessing these factors, but you will/should not outperform on a risk-adjusted basis. You can outperform by timing a cycle or getting a directional risk factor call correct, but that is beta and not alpha. You can get paid big for correctly timing betas, but it is even more difficult than finding genuine alpha in my opinion, and much less likely to be repeatable. Understand this and get comfortable with it, because being right for the wrong reasons is one of the worst things that can happen to you early in your career. By the way, if your group does not track some kind of risk-adjusted return measures, that should be a red flag.
At some point is not an investment strategy
Getting the timing of your calls correct is essential. This is less important if your thesis is built upon some kind of big secular driver over say a 5 + year period, but timing will still have an effect on every call to some degree. Fuck moral victories, no one is going to pay you 100 bps or 2 and 20 for a career of moral victories. If you identify a mispricing and a catalyst but it takes 3 years longer than you expected to play out, it dilutes the alpha of your call if it does not eliminate it almost entirely. Additionally, the longer a call takes to play out past your expectation, the more you expose your thesis to exogenous factors and the greater the likelihood you will be subject to thesis drift, which is a cardinal sin for an analyst. It is ok to be wrong, but know what has to occur for you to be correct and know when it has to occur. Do not get married to any idea and always be ready to admit that you were wrong and bail. If at any point during the construction of your pitch you find yourself thinking or writing “at some point” with regards to any part of it, either cut that piece out or rework that angle. Timing is essential.
Investing isn’t about evaluating businesses
It is, but that is only half of the game. The other half of it is figuring out what expectations are priced into the valuation. You can get the trajectory of the business and your fundamental estimates 100% correct and still be wrong. That is because you are judged off of your returns, not your ability to predict fundamentals. Your returns are generally an output of your ability to predict fundamentals, but at the end of the day you will be judged off of your returns. If you forecast a business to grow 5% but the stock is priced to grow 8%, and you end up being correct without realizing what is priced, you will be wrong. Valuation is about forecasting what you think will happen, and then sensitizing your numbers and talking to others to figure out what they think will happen. If there is enough of a difference, and assuming that you are more correct than others for whatever reason or edge you have, can you capitalize on it and be confident in the timing that others will see it your way? A good business does not necessarily make a good stock.
Know what you don't know
Be aware of the limitations of your research as a public markets investor, and be aware of the opportunity cost of the time you may need to invest into an idea to close certain holes in your thesis. For example, if you are looking at a multinational serial acquirer, know that you are going to be fighting an uphill battle trying to gauge the attractiveness of the portfolio as a collective and the attractiveness of the individual pieces on a standalone basis. Is this idea worth it? What is the opportunity cost of taking the time to formulate depth on the idea? Would your time better be spend on something easier to understand? The key here is to know what you don’t know. If a company has guided 100 bps of margin expansion annually, do you have enough information to reconcile that claim? Has management delivered on its targets in the past? In most cases you will be making some kind of call on management’s honestly and track record rather than being able to pinpoint exactly where the dollars will come from. The same goes for a new product launch or something along those lines. Will it work? Will you have some way to gauge early success? Or are you making a bet based more on faith in management’s ability to deliver and their track record in doing so? If you know where you could be wrong, or where there are simply holes in what you can know through public disclosures and information, you will have a much better handle on the business over time and you will have a better idea if volatility presents opportunity or risk. Always acknowledge and address these limitations.
Forget using multiples
Value investing is not simply buying “cheap stocks”. Buying cheap stocks is an implicit directional bet on interest rates and the economy, and it can work, but know that is what you are betting on rather than individual fundamentals. True value investing, and I would reason all investing, is about navigating mispriced assets. This could mean a stock priced at 30x should be priced at 33x, the same as it could be buying a stock trading at 10x that should be trading at 11x. To have any hope at accurately valuing an asset, you simply have to build out a full model and value its cash flows. A multiple is the bi-product of the interrelationship between returns on capital, forward growth outlook, and the discount rate, it is not a market anomaly or natural phenomenon. Without addressing differences in those factors you just can’t accurately compare peers based on multiples, and without addressing how those factors have changed over time, you can’t even compare a company’s multiple to its own historical range. The first book I ever read was Graham’s II, and I said ok all I have to do is buy cheap stocks, maybe trading below their cash balances or net asset values and sit back and outperform. That just isn’t possible anymore when any idiot can log into their etrade account and screen through 2,000 stocks in one click and there are billions of dollars flowing into quant strategies and quasi-passive etfs. Where guys get it wrong as far as DCF’s go is that it isn’t about precision, it is about forecasting a range of outcomes and sensitizing the numbers to different variables. In reality, multiples are just short-hand for valuing cash flows, and rarely in investing do you get compensated for taking short cuts. I have been fully converted to doing full 3-stage DCF valuations from my more multiple-based mean reversion beginnings. If investing was as easy as looking at multiples, which only requires the ability to be able to do elementary school division, everyone would outperform. "But everyone just uses multiples" Yes. And if you want differentiated performance you have to do something different. Don't be afraid to be different.
Valuation should come last
You really should never start with valuation in your research process. If you really think about it, it doesn’t make any rational sense to do so. You don’t go to the store with $100 and say I’m going to spend this on the cheapest items I can find. You go to the store with specific products in mind that you need, and once you have compared what is on the shelf and the differences in quality, you choose best priced item relative to that quality and your need. In investing the products you need are securities that will allow you to compound your capital at attractive risk-adjusted rates of return, so that is what you should shop for. When you screen for valuation, which will be multiple based, you begin from a biased starting point. We all do it, you see the 10x stock and say why is it so cheap or the 30x stock and say why is it so expensive? If this is a fresh look at a stock, you are just in no position to make a claim like that because you don’t know a single thing about the business or its trajectory. Break this habit and focus your earlier searches on what the business actually does and whether you find that attractive or not, the fundamental function of the business should be your starting point. Yes, you cannot quickly screen this way, but as with multiples, you don’t want to take short cuts when it comes to investing.
Don’t let an investment ideology or strategy define you as an investor
Even if you are working at a fund that is marketed to outside investors as value or growth or some other type of segmentation, don’t allow this to seep into your identity as an investor. You have one goal as an investor: to compound capital. I have found that people who identify as a value investor or small cap or large cap or growth or QARP or GARP or momentum or whatever the fuck you want to call yourself take some sort of strange pride in the titles. There is no nobility in shitty returns. Never lose sight of the fact that your one job is to compound capital, nothing else matters. Even if you are at a fund pursuing a specific style or strategy, investors will leave if you do not compound their capital, which is the only fundamental truth in this business.
Bad incentives can ruin good businesses
Always know what management is comped on and how that affects their decisions. Bad incentive structures can ruin good businesses. The most common case I come across is incentive structure that allows value destructive M&A to clear performance comp hurdles. Any kind of absolute sales or EBITDA numbers that are not based on organic growth or adjusted for M&A are deadly. The ideal compensation structure should be setup based on organic growth and returns on capital. Even TSR can lead to performance bonuses being earned for factors outside management’s control or direct influence. I don’t like margin targets either, as they often will incentivize margin expansion over value additive investment. If I was a CEO and the board said ok your bonus is based on an absolute revenue hurdle. I am going to lever this bitch up to the max and acquire all the revenue I can find, I don’t give a fuck about the long-term, you’re paying me too much in the short-term to care about the long-term, and I’ll be retired long before anyone finds out if these deals added value or not. Do the deal and slap some 5-year synergy target on it, retire after 5-years of max payouts. Life is too short and I’m going to get mine while I’m here. Always be aware of management’s incentives.
Your PM has to earn your respect
It is easy to look at someone’s track record and instantly give them credibility if it has been good, and if they are running any kind of sizable AUM they are probably well-polished when they speak about markets and the portfolio. Do not do this. There are a lot of idiots out there running money who were in the right place at the right time or were right for the wrong reasons on some big call. All it takes in this business is one home run to make a career as a PM. Give your PM the benefit of the doubt to start, but as time goes on make an honest assessment of the historical returns and how you are positioned going forward, and what that means for a long-term career with the fund. Don’t assume that longevity in this business implies skill, there is often a TON of luck involved with a lot of different guys. Make sure your PM has a repeatable process and isn’t riding a massive luck streak before drinking their Kool-Aid. You’d be shocked at how many guys out there are just complete idiots that were in the right place at the right time.
Tailor your pitch to your PM’s biases
If your PM happens to be on the idiot side of the spectrum, it is likely that they are highly biased with regards to their views. This is a major function of being right for the wrong reasons early in one’s career. Once you learn which biases have the most influence, you will have a better idea of what will work and what will not work. When pitching a name, highlight what you know will be received positively and keep the negatives more around the margin, if you talk about them at all. In a perfect environment, you should be able to acknowledge all the factors that go into and affect your thesis, positive and negative, and be able to have a rational, fact-based, emotion-free discussion around it. That is not the environment that I am in, and as such I am telling you how to get things done for the good of the portfolio. Remember the one fundamental truth, your job is to compound capital. Most investors don’t want to know how the sausage is made, and this is how someone can make a career out of being right for the wrong reasons (and how people get wrapped up in Ponzi schemes), but this is not sustainable over the long-term. Therefore you need to bring in ideas for the good of the portfolio, which is in your best interest to do so if you want a long-term career. At the same time, you must balance this with what will score you points with your PM. Do what you have to do to achieve this balance, even if you have to tailor your pitch to conform to irrational biases or leave out facts that would be relevant in a normal environment. I’m not telling you to make shit up, but be selective with what goes into your pitch for the good of the portfolio.
I think that is enough for now. Again, this is all my personal opinion from what I’ve learned over my first few years as an analyst. Hopefully someone finds it useful.
Thank for putting so much time and effort into making this post. Super useful and spot on. This is the type of content that this forum needs. Curious to know the type of firm you are working at/ how you got here / where do you see your career going next few years?
I've been at an insurer where we run our US equity allocation internally. It is siloed from the other asset classes and we run it the same way you'd run any other long-only equity fund. We describe our strategy as value-oriented or a value tilt in our quarterly board letters but “we” are really just buying cheap stocks primarily based on their multiples (which I don’t agree with or think will lead to good results long-term). I came in just applying through a normal job post, having passed L1 of the CFA helped at the time and I also pitched two energy stocks without knowing I was pitching to their energy analyst. He had the same views of the companies as what I presented so I got the job. In the next few years I would like to move to a concentrated long-only. Right now we own over 100 stocks, which isn't meaningfully different than any other of the typical large mutual funds, but I talked about trying to find the most optimal path to compounding capital, and in my opinion a more concentrated fund is the best structure. I don’t think a lot of guys have 100 good ideas but they own that many stocks to reduce tracking error, as do we, but in my opinion you just end up diluting your best ideas. I’ve always been a believer in the concept of your best five ideas being better than your next five. My personal passion is also doing deeper research. I talk about assessing whether the opportunity cost of time to gather depth on an idea is worth it or not. With how many stocks we own and that I cover it often isn’t. This is less of a concern at a more concentrated fund where you will likely spend months on an idea before getting it into the book if you get it in at all.
One benefit of being at an Insurance company is that our capital is permanent and stable, and our board and CEO believe in active management. It is not lost on me that the mutual fund industry is in broad decline, but I think that is more so a function of them all being structured to be AUM grabs and incrementally tacking on the management fees to their top lines. I think those businesses have further to fall, but there are some good concentrated long-only’s out there that are focused on the right things and have solid repeatable track records to back it up; however, this greatly narrows my potential exit points as there simply are not a lot of seats at those types of funds. I’m not completely opposed to going to one of those funds if the pay is good enough, but my preference and long-term career goal would be to go to a more concentrated fund. Our PM here is also FINALLY retiring and I am more optimistic on who I think will be his replacement, so I am not in any rush to jump ship. Another reason for wanting to exit besides fund structure and strategy is that right now I am fairly compensated for my experience and credentials, but as I become more senior the spread between what I could earn here vs at a more traditional fund begins to widen. So in the next 2-3 years I would look to be more aggressive, but right now I am just passively looking and curious to see what happens after our PM transition.
a good friend of mine is an equity analyst at a very large long only fund (moved there from sell-side ER). if you'd like an introduction, i'd be happy to make it
Ya PM me when you get a chance
Hi, I'd like an introduction too please.
very bold
How'd the intro go my man
macro boy here but still found it insanely helpful, thank you
Wow you are extremely knowledgeable. Just curious what your current or the average salary is for a trader? Also is that your official title? Are you compensated based on any successful deals you help bring about? I’m in high school and am looking at future career opportunities any info would be appreciated!
Thank you.
Thanks for taking the time to write this post. I just took the CFA level I and I am hoping to get an equity analyst position not long after I get my results back (hopefully a pass). I am in the process of learning what being an equity analyst really means and this post was certainly helpful. Any tips on sticking out in the interview process?
Have two well thought out pitches and don’t pretend to know anything that you don’t know, like I said in the original post, know what you don’t know and acknowledge and address how those holes affect your thesis. Also have some structure to the pitch, walk through the different pieces of it in an orderly manner. If you can chat with someone that works there before you interview and ask them how they typically write up and pitch a name that would give you an advantage, some guys like a shorter and more concise 1 or 2 pages, others prefer more information over less. I tend to skew to the lengthier side because I know my PM won’t read the full thing and when I pitch the name in person I can only highlight the points that I know he will receive positively. This covers me in the future if he happens to learn something about the name he wasn’t aware of that doesn’t perfectly fit his biases. He can’t/won’t come to me and say “you didn’t mention that” he cares more about not admitting he didn’t know something or didn’t thoroughly read it than actually knowing something or reading it thoroughly. He also knows that I always present all the facts in my write ups, so he will just assume that it is in there if he doesn’t actually go back in and reread it and find it.
For me I like to structure my full pitches/write ups in the following way:
Trade Recommendation: Buy/Sell Company Name (Ticker) Suggested Position Size and implied trade size (probably not relevant if you are interviewing)
1-3 sentence elevator pitch, discuss the premise for the trade and I usually also tack on my fair value estimate to the end of this section.
Company Overview Segments and products/services, what do they do? How do they actually make money?
Industry Overview Industry characteristics such as growth opportunities/TAM, competitors, what companies compete based on, historical rough patches of industry demand/capacity/pricing fluctuations. May also discuss geographic exposures and will have to cover multiple industries if diversified. If really diversified, growth relative to GDP may be the most relevant place to focus.
Competitive Advantage How is this company going to compete within their industry/industries? Why are they earning above- or below-average returns on capital? What is their level of pricing power and what threatens/preserves their pricing power. A large distinction I would caution you on here is that there is a big difference between a competitive advantage and a competitive strength. Always be thinking about competitive advantages in terms of how difficult would this be for competitors to replicate and is this subject to disruption?
Capital Allocation and Management Capital allocation priorities, dividend/buyback trends and thoughts around their buyback discipline (More fair value based or more programmatic? Actual capital return or just there to offset dilution?) M&A history and current pipeline, management’s capital allocation record at previous firms if applicable. Thoughts on management’s track record over time in current position or at previous firms, incentive comp structure, how much stock do NEO’s and the board own. I also tend to include any sizable institutional ownership in this discussion if it is meaningful.
Valuation and Catalysts Discuss your model, estimates and assumptions made and why your estimate of fair value differs from, or conforms to, the consensus and market price. Side note: Given that I primarily screen for what I think will be or are good businesses, I might get all the way through a name and say it is fairly valued and there is not much to do here. This is fine because now you have completed the research and laid the ground work to do something on it if an opportunity presents itself. On catalysts, discuss both upside and downside catalysts and the timing of them (others may call this section catalysts and risks)). Discuss the level of certainty around catalysts and time horizons. I know I just said forget multiples, but I have to talk about them here because my PM wants to know what they are. Multiples also can provide a decent sanity check for your model and estimates. Say if your fair value implies it should trade at 20x and it has never traded lower than 30x, that’s a decent signal that you should go back in and sensitize a few different variables again to see what is being priced but DO NOT simply adjust your numbers to get closer to these multiples, just don’t do that. Also if you must focus on multiples, FCF/EV as a yield is probably your best bet but I know some people just simply can’t function without knowing what the P/E is, so just know your audience. Key themes or points to address in this section are what is the market missing, why is the market missing it, why are my estimates better than the consensus (do I have an edge), how will the market realize that my fair value estimate is correct. A mispricing can persist indefinitely if other investors don’t eventually see it your way. As I mentioned in the original post, the timing of this is essential for you to actually generate excess returns.
Recommendation Alright you’ve laid it all out, now what do you think we should do? This is the extended version of the elevator pitch at the beginning. What are you recommending and why does what you have laid out here support that positioning? How much can we make, how much can we lose? Where are the holes in your analysis and research? How are you going to track this idea going forward and what will you be looking for to indicate the thesis is on track or should be abandoned?
Lastly I tack on the financials tear sheet and any charts that might be relevant as like an appendix. Some prefer to see this information upfront, but given that most people (not just PMs) will start to form some kind of initial view which will be based on an arbitrary view of these numbers (hence forming an initial bias one way or the other), I prefer to structure it this way so that reader learns about the business and the industry before connecting that to the numbers.
Last piece of advice for interviewing is know some of the recent macroeconomic data, current events, and where things have been trending. Never make a directional call on the market in the short-term. The perfect macroeconomic forecast is to present upside and downside risks/catalysts without ever firmly committing to a view. The safe play on the “where do you see the markets going” or “how do you feel about the current economic backdrop” is to layout these cases but always qualify it with something like “It’s impossible to accurately make short-term directional calls and I try to keep my sights set on longer-term horizons”.
Thanks a lot. I will reference this for sure when I start diving into the interviews.
Thanks for the great post. Could you add any color in approximate comp progression from analyst to PM at your firm?
So I don't know how applicable this will be to others because most of my professional contacts and network are at normal funds or on the sell side, but I will give you some ranges based on the salary grades I have been at. Also want to note that I am in a city with a cost of living comparable to Chicago, so expect these numbers to be higher for the larger metros. At the end of every year I get a sheet of paper with my bonus information and what salary grade I'm currently in which gives the ranges. This is based on how I ended the year and not how I started, but when I started I came in at 62k. I got a bump that year and range for my grade was 63k to 92k at year end. The next year I got one title promotion and bumped up a grade for which the range was 71k to 106k. I got two title promotions over the course of year 3 and ended within a range of 90k to 136k. As I mentioned, I am wrapping up year 4 and I can come back and update you on my new range once I get it, but I did not get a title change this year just some little percentage bumps that moved me up within that range.
As far as bonus goes, our target payout is 50% of base capped at 100% and it is based primarily on 3-year returns with a very small discretionary component and some kind of override if the 1-year numbers are exceptionally good. More of an aggregate of the group’s returns and the department as a whole than my specific calls. I have less insight into what the more senior analysts are making or our PM but I expect both to be making less than they would at a normal fund with the same level of experience on base given what I do know. All in all it’s not bad for what it is, but comp isn’t my only motivation to be at a more normal fund.
You mentioned you have contacts at regular long only funds, so I am curious what would you roughly expect your salary and bonus payout to be at one of these funds with your level of experience?
This and another post below is phenomenal and should be a must read for anyone interested in going into this space. SB'ed
Especially the part about luck and pitching to PMs. We are all human and so we have to tailor our pitches to the audience.
This is what's missing from most analysts pitching to their PM's, but also applies to most jobs. Knowing your audiences tendencies, bias, and preferences definitely has a massive impact on how successful your pitches are.
I hold a different view on this. The point of a pitch is not a binary event of “does it get into the book or not and at what sizing”, but a conversation about a developing opportunity. The implicit takeaway about tailoring to PMs biases only serves to maximize the analysts rewards while the fund/PM takes the risks. I think In the original post mentioned that this does not mean obfuscating research, but from my personal experience I’ve seen guys producing biased, and eventually, wrong views because they wanted a higher chance at more PL contribution at the end of the year. I agree that pitches can be tailored to the audience but only superficially and definitely not at the discount of a well thought out, properly researched opportunity. This could be very different for insurance-siloed funds and large long only’s but in my experience in HFs, only the truth matters and by truth I mean the analyst had exhausted all information and have derived a highly probable scenario whether long or short. Leaving out key details, especially for the reason stated by the original post, is dangerous, especially when the fund becomes more concentrated. Overall great post and I agree with most of it, but was taken by surprise regarding this particular segment given your original well thought out views on fundamental research. Being confident about your research is one thing, but spinning is a whole other issue. Lastly, I may have missed the more nuanced implications of your views on this and if so, please point me out what I may have missed. Thanks.
Great post. This is extremely insightful for those interested in that type of role.
You talked about how you understand why most employers require that 5 years of previous experience. If you weren’t able to get your current role out of undergrad, what do you think you would have done prior to the equity analyst role?
In other words, what is a common background your colleagues have that didn’t come straight from undergrad?
I actually didn’t get in out of undergrad, I spent a year at BAML/JPM/MS type shop in a client facing role and passed level 1 of the CFA while I was there and got the 7/66 and all that. The benefit of that was I had daily exposure to the equity markets and could talk about different names from talking about them with clients. I was also more plugged in to the news flow and what people were worrying about. So I thought that was a decent first step and those types of jobs are pretty easy to get if you have or can quickly pass the licenses, which anyone can really. Prior to that I had an accounting internship and in different interviews that was talked about as much, if not more, than the position I was currently in. I think some kind of accounting or financial analyst position was my next step to get closer to breaking in, all the while I was planning on wrapping the CFA program, so that was probably going to be my approach if I had not landed this. I actually went on quite a few interviews and had a lot of phone screens and what not before I got this and I’m not gonna lie, it was extremely frustrating. But you just gotta keep your head down, keep doing the right things and worry about what you can control, which for me was deciding to do the CFA program and persistently applying everywhere I could. Coming from a non-target that is all you can do, just grind and add spokes to your wheel, keep improving your profile. I would say most of my colleagues went to better schools than I did (not difficult to do) and some of them had similar client facing or PWM style investment roles/accounting + some of the CFA before coming on board. Our PM is big on the CFA and I don’t think I get the look without having passed level 1 to be honest. I also was like one of the first people they interviewed because I had applied within hours of their job posting. I was really active in looking for different opportunities, so I often was on top of things right away. Most online portals probably are black holes, but I do think you improve your chances by being on top of the pile sometimes.
As an aside, I know most people on this board will tell you networking is your best bet to break in, and they are probably right. I have not mentioned that here because it just did nothing for me. Mind you my network sucks ass. If you want to tap the alumni network at my school I am it, I am the only one in this type of work. So the bulk of my networking attempts early on were through cold linkedin messages, very low hit rate, but that’s really all I had. I would get some decent advice from these chats but no one was leaping at the chance to hire a non-target before I cleared level 1 of the CFA. I come from a blue collar family and we really don’t have any relatives working in finance either, believe me I’ve tried and asked.
Even today this is probably one of my weakest professional qualities that I am not actively networking. My contacts that I keep in touch with have been either sell side (we pay them to talk to us, so I don’t know if I would count this) and through reaching out to people who owned positions that I was in or looking at, or just shooting the shit at a conference. I need to get better at this especially if I hope to move to a concentrated long-only at some point as they rarely openly post for positions or even have seats open up.
Outstanding. Your posts reinvigorate my desire to work in AM/HF long-term. Been a long journey to get to this point but I gotta keep pushing. If only for a chance for me to ascertain whether I am good enough or not.
When I write these things up sometimes I think maybe people won't find this useful, but then I say fuck it at least BobTheBaker will read it and like it. You've already taken solid steps in the right direction, keep grinding.
A lot of people read the long posts, especially if they're well written and insightful. I think your posts really help people learn what the job is really like, which is key in an industry where people tend to have long term careers. So 1+ SB from me
I'm 6 mos into a long-only fund and refining my first real idea right now... Thanks for the post, found it helpful
This is a great post. One of the paradoxes of this business is that the longer your track record of delivering alpha, the more likely you are to ignore hard facts/data and rely on gut feeling or intuition. Almost every PM I have worked for has been an egomaniac and the overriding attitude has always been "I'm richer than you and I have a track record and that makes me smarter than you." I once had a PM come back from a lunch (mid 2014) with a friend and he told my manager and I that we had to buy this Spanish construction company called FCC (FCC SM is the ticker). The reason we had to buy it was because Bill Gates' investment fund and Soros had just bought some. So I sit down and run the model (DCF, SOTP, multiples, etc.) and come up with a value of EUR 12/share vs. stock price of EUR 11.80/share. My manager looks at me and says "you can't bring that to the PM, he wants to buy this thing so we need to come up with a better price." So anyway I left the model and we ended up buying the stock anyway. The stock was basically range-bound and today today trades at EUR 9/share.
Now here is the key red flag you need to look out for with a PM. If you disagree with your PM and are right, does he acknowledge that fact and start listening to you more? Or, does he turn the blame back on you and say you should have shouted louder to make your case more convincing? If it's the latter get out of there as you are stuck in a lose-lose situation.
Secyh and Ovechkin always come thru with value add posts/comments in the AM forum. Respect!
Hey Secyh, great post. I am curious to know if you have any resources to enable me to further understand the value drivers in a business. I am currently reading Valuation by McKinsey as well as some 10Ks. Thanks for always providing great insight.
The McKinsey Valuation book is one of the best. There's quite a bit of valuable free content out there on the web: Aswath's blog and public resources are quite good. You can also find quite a bit of work from Mauboussin that I've found to be helpful.
In broad terms of value drivers always be thinking: how does this affect the business's pricing power and how sustainable is it. That high level concept is what you always want to come back to when evaluating different aspects of a business. Pricing power is everything, cost advantages are less durable over time IMO.
I willtry to get my hands on anything Mauboussin has ever written. Thanks for the tip I will try to read more Damodaran. Could you expound on the alpha vs beta remark? As far as I am aware beta would be if the stock moves up or down because it is correlated with the general market.
Yes, you are referring to equity beta as in broad systematic market risk, but as we know today there are many different risk factors that help to explain returns. I created a risk factor model for us and wrote up a white paper on it for our board of directors. Here is an excerpt:
“The roots of factor investing can be traced back to the 1960s and the advent of the Capital Asset Pricing Model (CAPM), which today is still the foundation of asset pricing. The CAPM model can be decomposed into two risk‐factors: systematic risk (market‐wide or undiversifiable risk) and idiosyncratic risk (company‐ or industry‐specific risk). In the decades that followed, academics and practitioners discovered other factors and risk exposures that were persistent in the explanation of equity returns. Today there are a plethora of different factors that have been proposed to generate excess returns; however, it is important to distinguish between factors that are genuine anomalies (deviations from Efficient Market Hypothesis resulting in excess returns), and factors that merely explain risk (excess returns that when viewed on a risk‐adjusted basis are only adequate relative to the additional risk assumed).”
There are quite a few different proposed risk factors (value, quality, size, momentum, volatility) but let’s take the value factor for instance. The existence of a value premium is considered to be a well-established empirical fact, but there is considerable debate over whether the premium is due to taking excess risk (lower quality and riskier companies trading at commensurate discounts) or if it is a genuine market anomaly (overly pessimistic valuations stemming from an emotional or psychological mispricing of risk). I think there is enough research out there to support that there is probably some truth to each, but before risk factor research gained prominence, value managers were considered to be generating alpha because a value beta was not recognized as the source of returns. You only truly generate alpha if you outperform with less risk, meaning, you are able to defy the rules of EMH. As I mentioned elsewhere, you can outperform the market by correctly timing a risk factor, as in putting more risk on at the opportune time (rotating from value to growth or momentum or whatever), but on a risk-adjusted basis you should not generate excess returns. You would be surprised how much short-term market moves can be explained by different risk-factors, or at least appear to be explained by different risk-factors. I wrote up another post discussing how a genuine mispricing can materialize (what you need to generate alpha), link here.
SingletonMalone37 Meant to hit reply to your last comment and not just add a new comment to the thread
This is great writeup. Only thing I disagree here is with factor timing, if you can do that correctly then you are generating alpha on a risk-adjusted basis. All good value investors are doing factor timing for the value factor. By the way, are you allowed to share the full paper? Are you supporting a fundamental team?
In theory, if you are factor timing you are putting on an adequate amount of risk relative to that factor, and hence not generating alpha but simply adjusting your levels of risk. With regards to value investing, it depends on what you define as “value”. If you define value as intrinsic value, then you are looking for deviations in EMH. If you define value as statistical value, then you are just factor timing and really betting on rates and macroeconomic trajectory.
This was a paper that was distributed internally and I probably shouldn’t post the whole thing here. I am on the fundamental team and creating our model was a project I worked on to be used as a tool for our team.
Awesome. Thank you for this!
I wanted to drop in this link to Howard Marks' latest memo in which he expands upon some of the things I have talked about in my original post. It is quite good and worth the read.
https://www.oaktreecapital.com/docs/default-source/memos/you-bet.pdf
Just passed CFA Level 1 working at fund of funds, want to switch to company analysis. thoughts on trying to do IB first and then get into HF? or maybe do ER first? Do firms care about one vs the other?
IB for hedge funds
ER for long only
It isn't as black and white as I've just made it seem, but that is just what I've found to be most common of the options you've listed.
So it would be harder to get into hedge fund from ER compared to IB?
How do you decide what companies to analyze if you don't use valuation metrics as a screen? I imagine it's challenging to find where to start. I would say that I'm currently in the camp of looking at stocks trading near their lows in terms of valuation and then doing a deeper dive on how much downside/upside the company's earnings to determine if the company is a worthwhile investment. Interested to hear your thoughts as I'm always looking for new ways to discover worthwhile investments.
The strategy I've found the best results with is to just segment my coverage by industry groups and then just work through as many companies as I can in the group. I find this to be the most effective method to source ideas because a lot of times accounting numbers need to be adjusted and a company that might not look that great in a fundamental or valuation-based screen might actually be more interesting than the numbers suggest. This can be more time consuming than filtering your universe with a statistical screen, but you get better at it with time. At this point after some high-level diligence I can determine whether it is worth my time or not to do the full dive, as I'm looking for a handful of key attributes that are often apparent early on if the company possesses them.
Thank you a lot for such good insight, it helped me learn quite a lot about the role of an Equity Analyst.
I am currently studying at University and wanted to go to buy-side to be Equity Research analyst, your explanations were well written and covered a lot of topics. I am currently reading Graham's Intelligent Investor and Damodaran's Investment Valuation books, can you give any other advice on what additional steps I should take (or learn) to get into Asset Management industry?
Just to add I recently had an interview, and now after reading your guide on how to do a stock pitch, I understood how pathetic my answer should have sounded. I will learn though, thank you a lot.
Realize that the takeaway you want from Graham's book is the mindset on being an investor vs a speculator, that is the most important lesson, a lot of the actual valuation methods don't really apply today. I would also recommend McKinsey's book on valuation, it is probably one of the best resources out there.
I believe you can take level one of the CFA program while you are a senior in UG as well, looking back at how much free time I had as a senior I think it may be worth-while to take that early, will give you an edge coming out of school. Other than that network with alumni if your school has a presence. My school unfortunately has none, so I have to defer to meeting people at industry events and cold messaging, but when you eventually do get someone on the phone you usually learn something of value either with regards to research or to the culture of the firm they are at. Numbers game there, every no you get the closer you are to a yes, don't take it personally if people ignore you (although it does affect my opinion of the firm's culture when no one responds).
Thank you for this post. I want to enter asset management out of UG (2nd year, standard 2:1 student) but i have no experience and a non-finance background, but at a pretty good university (top 20 uk). Im currently reading the intelligent investor, in my unis investment society and have a place on the financials team as an analyst in the investment fund.
I'm gonna pick up the mckinsey book on valuation as someone noted in an above comment. Do you have any advice on what i should do next to get into your position? Thanks
Sounds like you're on the right track. I'm not familiar with 2:1 in the UK but assuming that is still part of a 4-year degree I would obviously shoot for an internship over your summers. An internship at an asset manager would be ideal but really anything finance related would help your cause. During your senior year I believe you can sit for level one of the CFA program, which I would recommend if taking on that extra work load is within your limits.
Thanks for your reply.
I imagine could fit CFA level 1 into my schedule, I've been giving it some thought. My only issue is most UK UG courses are 3 years, and such is true with mine. I'm still looking around at positions for the summer hoping I can get a finance based internship. After this academic year for me it would be graduate recruitment and I cant help but feel that I'm going to be a disadvantage without some work experience. Other than that I could try and get a Masters degree in finance. I will have the grade (2:1 is around a 3.5 GPA I believe) required but may need to pass some prelim exams as my degree is non finance.
What are the core skills I should be looking into improving/getting up to full time analyst level for asset management? I think my best bet at getting hired out of undergrad is to present a skill set that is needed to for the job and to be more than capable in the role I will perform, so what are the main day to day tasks in your role that it would be worth the time to master? My plan is to build this skill set and I've got 6/7 months till grad recruitment rolls back around to pull it off. I believe i can do it but i just need my learning to be focused.
Be familiar with excel and perhaps you could take one of the modeling self-study classes like WSP. Most likely for an entry level role you'll spend most of your time working on models in excel, and that is likely something they will test you on in interviews aside from high level conceptual knowledge. Would definitely recommend the McKinsey valuation book, I think that is probably the best resource on the topic.
The skill set to be an analyst is very basic. Being a better writer, reader, modeler...none of that is really differentiating. It is the minimum expectation that you will be proficient in those areas. In my opinion, being a good analyst has more to do with temperament, perception, and self awareness. You really want to form an understanding around how humans think and process information, it will help you recognize your own biases as well as identify potential biases in others and how they could be affecting market sentiment. Here are just a couple I've read that I think would be useful: Thinking Fast and Slow, Influence from Cialdini, Presuasion also from Cialdini, and Freakonomics. The CFA text, if you decide to go through the program, will also elaborate on psychological biases specifically in the context of investing and I found that to be some of the highest quality content in the program.
Thank you for your advice. Which edition of Valuation would you recommend? I'm grateful you gave my comment the time of day in this thread. Best wishes!
thank you for the advice!
Any chance for some one breaking in from corporate development?
I don't see why not, the technical skills are probably the same. You could have an edge going after the particular sector your company is in as well if you can demonstrate that you have solid industry level knowledge.
I see, would a CFA be much value add in my case? Already have a CPA and not quite excited by further study and length of time required to get a CFA (I enjoy and learn a lot from personal investing and would rather dedicate time to that for example)
Firstly thank you for writing this, it's super useful! A couple of questions:
1) How do you evaluate the worthiness of pursuing research? As you mention, sometimes the investment case might just be too complicated to be worth the time. If you'r a junior analyst with limited experience, how can you assess how long research might take you and if it's worth it?
2) Do you find that when pitching, if a PM asks a question you cannot answer, it undermines your pitch as a whole, irrespective of whether the question is relevant or not?
3) DCF's (part 1). Many people where I work criticise them because they say analysts get too wedded to their model and can't see the wood from the trees. Have you experienced any short sightedness from preferring DCF's? Have you found that the range of outcomes for some companies are simply too wide for a DCF to be useful? (part 2): how long did it take you to get good at modelling? How would you recommend someone learn this from scratch?
4) investment philosophy: I appreciate this will have evolved, and will continue to, but do you think you've developed an investment 'style'? Are there any investors you look up to/appreciate their process - if so, are they?
1.) I can usually start to get a sense of it in the first two steps of my process. I absolutely always start with some kind of company history. This can be the company’s own website, wiki, funding universe has good history usually, but usually just searching to find a history. Take notes of any interesting articles that you might come across on the company as well, very informal. I find that if you know how a company got here, you’ll have a better idea of where they are going and the company culture. So right in this step you can start to get a feel. Has the company always been focused on a niche, was it more diversified and spun things off, is it diversified because that’s just what you did in the 80’s/90’s or does the portfolio fit together? My second step is always to read the K line by line. Here if I don’t start developing a sense for what drives this company’s value early on, that would be a red flag. I’m really looking for: what is their focus, what is their competitive advantage? The names I most often find are too complicated are the holding companies that are in a bunch of different unrelated shit. I can make an exception if management has a really clear articulation of their capital allocation philosophy and I can confirm that they actually practice it looking at their numbers and recent deals. 2.) Absolutely it does, because it tells you right then and there they are just not focused on what is going to actually drive the value of the investment. Part of that though is our fault, because clearly we haven’t articulated the opportunity well enough to maintain focus where we want it to be. Now those comments are relative to something you can’t answer because it does not matter to the thesis. If they ask something that could be relevant that you simply had not considered or given enough weight just say “hey that is a good question, I’ll have to go back to my notes and follow up with you after”. If you have a good team/PM likely there will be questions like this, and I would say that no, this would not necessarily undermine the pitch if it was relevant. If it was a big piece and you simply missed it then yes, completely undermines it, but it should because it means the pitch wasn’t ready to go forward. 3.) The guys I work with are similar (part of why I would like to move on to a better shop). “Oh you can make a DCF say anything you want, sensitive to the inputs”, “Your DCF goes out to 2065, you can’t possibly know what is going to happen out to 2065?” That is just not what a DCF is about at all and using multiples is an implicit DCF except you don’t appreciate the individual components. I’ve come to see mean reversion and historical multiples or comps as useless for that reason. I simply go through my process as I normally do finishing with a full DCF-based valuation and then I will also go into some discussion of multiples to check the box for them. I do not give half a shit about what the multiple is, but if it’s trading at the highest absolute multiple it has ever been at I’ll say rates have never been lower or their ROIC has never been higher. Or if the relative multiple vs the SP or a peer group makes it look better I’ll highlight that. In truth, I am relying on my cash flow valuation, but this is my workaround. I honestly think that it takes a bit to get comfortable with modeling and you just have to keep doing it. Some of the inputs are more art than science but that does not invalidate the process. Incremental return on capital is a key input in my models but it’s very difficult to back an accurate measure of that out explicitly from a company’s historicals, especially if they are acquisitive. My modeling intro was WSP self-study which I would recommend to form the basis of your understanding on how the three statements connect in a model context. Then, as I have mentioned elsewhere, read the McKinsey book, Aswath’s blogs and website, Mauboussin’s pieces, ect. Then just start doing it and you’ll get better at it. Also, if you get a wildly different estimate than the market price don’t just assume you fucked up and start adjusting your numbers to get closer. Start thinking about the ”why” and what might be priced. You should have at least the sell side perspective on it as a starting point for this. 4.) As I mentioned in the original post, I don’t believe in painting yourself with a particular style brush. Remember, we have one job: turn the money that others have given us into more money, that is it. It does not matter how you get there but to last in this business it has to be something repeatable. To me, the one thing that will never change is that businesses in attractive industries with competitive advantages that you pay a discounted price for will always result in outperformance. There are plenty of other ways to make money in the markets but that is what I find to be repeatable and something that is durable.
Thanks so much for the detailed response, that’s incredibly useful. Great to know sometimes you just have to do things to tick the box for your PM and not necessarily because you think it's useful. It’s funny how while ultimately your performance comes down to numbers, you still have to ‘play the game’ to an extent.
Out of curiosity I’ve got a few more Q’s, no obligation to reply of course, just super interested in your experience.
If you work at a shop that doesn’t favour DCF models, how do you have time to do it? What time frame are you given to conduct new research and revert to your PM/team?
What is your opinion on sell side analysts? Some PMs I’ve worked with value them highly and others don’t even read their research. At my experience level, almost everyone has more insight than me so I’m always listening and reading what they have to say. Curious to see whether that might evolve over time.
What gaps do you think you have in your skillset and how are you addressing them? I am signed up to complete CFA level 3 (now in Dec, thanks to COVID), I expect I’ll have a lot more free time after this. If there were 1 or 2 things you’d recommend I do with the free time, what would they be?
Your part about ‘tailoring your pitch to PM bias’ is probably the best piece of advice I wish I already knew! I’ve been criticised in the past for my pitches being too ‘on the fence’. From my standpoint if I think we should buy a stock, I believe it’s irresponsible for me to not mention why I might be wrong & potential magnitude of downside. Others have taken this as me being ‘not taking a side’. It sounds like you’ve nailed walking this tightrope of pushing the right buttons to get things done. However, do you think this has inherent dangers for your thought process and potentially for the fund? Have you had a situation where you’ve pushed to buy a stock and kept negatives at the margin, and then the stock performs poorly due to those negatives? If so, how has your PM reacted?
Thanks again for your response! Hugely valuable.
This was a very great post. For someone currently transitioning from sell-side to buy-side, this is a great reference piece.
Curious about the thought process that led you to deciding on doing a part time MBA. Do you think you would be able to switch funds or become a pm one day without it? It seems like an expensive and time consuming “check the box” thing do with already having a CFA and a number of years of buy side experience.
Not trying to disparage, as I have a similar profile (besides the CFA) and I have been considering the idea of doing a top 20 part time or online MBA. My thought is I really only have the time for CFA or MBA and while I really enjoy my role at my current fund and have performed well, I’m not too positive on the long term outlook at the fund or the industry in general. While I would like to have a 30-40 year career on the buy side, my thinking is the MBA would give more flexibility to change industries albeit it comes with a much higher price tag than CFA.
Would love to hear your thoughts on the decision of part time MBA and any thoughts on my rational of part time MBA vs CFA.
There were a few different reasons I decided to go the part-time route: -It seems like the new standard in the industry is MBA + CFA at a lot of top funds that I would be interested in joining -Coming from a non-target undergrad, I wanted to rebrand with a better school. It's really the only thing anyone can hold against me right now and I'm addressing it -Don't have to leave my job and will continue to tack on additional years of WE -Don't have to give up two years of pay -Same reason as you, insurance policy on a 30-40 year career. If I got fired tomorrow there really aren't many jobs I could jump to with just the CFA. MBA gives me better optionality -Saw attractive value to the particular program I chose from a cost perspective -More marketable if I decide to setup my own shop someday (long-term goal/aspiration)
It really checked all the boxes I wanted to check besides the networking aspect and perhaps access to on-campus recruiting (certainly two high-value aspects of going full time). I also get about 11k in tuition reimbursement annually from my current employer and should spread the program over 3 calendar years, which further helps lower the cost. It was a decision I put a lot of time into and I'm happy with it so far, just made a lot of sense for me.
thank you so much
OP - you do a nice job of simplifying the complex. That's a very important skill to have regardless of role, especially if you want to move forward in a career. Even more challenging in a highly technical area, so again congrats. The ones who can get new opportunities. The ones who can't remain on the rock pile.
Bookmarked. Great write up
Thank you for this invaluable insight. If I can throw you the whole banana tree I would. Top post.
Just starting my career in Private Banking and I cannot be more grateful for your post. it's exactly what I feel I would need to do. Thank you
Thank you! Really appreciate the time you put on writing this 🙏🏻
I have some questions for you, are you an ER analyst? What would be the differences if it isn't your case? What is your current career path? How is your comp like? Thanks for this great post!
bump
Could you do another reflection piece like this?
Yes, I recently made the jump to a solid LO but it is still very fresh. Once I have had more time under my belt I will write another post about the differences, interviewing, comp...
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