Basic Guide Ramping Up On A Company With Public Information Part Three

In part one we covered the basics of understanding a company, which involves reading the s-1 filing, reading the quarterly reports and understanding the drivers of both revenue and costs.

In part two we begin building out the financial profile, understanding the valuation metrics and finishing up with a financial model that is in-line with Street expectations

In our final segment we will explain how to come up with a differentiated opinion, again this will vary by company and you’ll have to adjust your process appropriately as no person or firm will likely view a single security in the exact same fashion. With your financial model in front of you it is time to start digging into management, valuation and sustainable long-term growth.

Management. A significant piece of valuation for securities is within the intangibles. One main intangible is the consistent execution and delivery of a strong management teams. The main negotiators and sirens for the firm should deliver a clear message, set expectations appropriately and slightly exceed said expectations. For example if your company has the best operating margins and free cash flow for your industry, you will become an attractive security due to performance alone, however you must set the expectations appropriately. As an example, if you are promising 10% revenue growth in a space where 5 % growth is average, you will not be given much credit for delivering 6% revenue growth as you are setting the bar much higher than your results. Even though 6% growth would see investor interest, it would be wise to set the bar at the average (5%) and execute slightly above (6%). This gives the company more credibility and investors will take note.

A good way to gauge the Company’s ability to beat and raise, is to simply review guidance on historical conference calls which can be found in the investor relations section of most company websites

Going with the Facebook example, the management team is still relatively new so you can peg this as neutral to negative unless you have a differentiated opinion of Zuck & Co.

Clean Numbers. As many of you know the income statement can be manipulated quite easily so it is important to look for any accounting discrepancies that could explain a valuation divergence. An obvious but simple one would be comparing Non-GAAP numbers to GAAP numbers, a company that reports solely on a GAAP basis with no history of restructuring charges or other one time events will likely deserve a higher multiple (earnings basis).

Notably, Facebook is a standard Internet tech stock from a financials perspective, so it reports both GAAP/Non-GAAP numbers, most models you find will run with it on a non-GAAP basis. With this in mind the multiples should be in-line with the peer group.

On a glance, no positive or negative move from a financial statement perspective.

Differentiated financial model. Generally speaking, if the company reports guidance that is roughly in-line with actual results on a quarterly basis, consensus numbers will center around the mid-point and your estimates will reflect normal seasonality. Based on your new knowledge of the space (growth rates of users, demographic shifts, expected products and use cases for the firm etc.) you should have a differentiated financial model. This means your “real” expectations are likely above or below consensus numbers is a meaningful way. This differentiation in revenue growth and earnings power should drive some extra upside/downside to the current stock price.

Peer Group. Here is where many debates arise, by now you know if you approve of the management team and you have dialed in your expectations for the future financial performance so now it is time to decide what multiple the company (Facebook) deserves. You’ll need to look at the comparables (LNKD, GOOG, BIDU etc.). Cutting to the chase in simple terms since this is a basic guide, the best bet is to look at your numbers and decide on the long-term revenue and EPS growth rates. This should then be compared to the peer group where a higher or lower multiple is warranted.

The Final Lap. At this point you’re wrapping up and its time to take a stand on the stock, you have 1) an understanding for management, 2) a strong and differentiated financial model, 3) worked out possible valuation disconnects due to accounting changes, restructuring charges, charge offs or other wise and 4) understand where the company should trade in your view.

With the grunt work out of the way the final step is coming up with a differentiated metric/opinion/view that the Street may not understand. This is general for a reason, because the final step is always the most difficult. Ask yourself the following questions now that the numbers and management team are out of the way, again focusing on facebook as the example:

1) Will new products and services for Facebook be more margin Accretive?
2) Is the total addressable market under/over estimated, why?
3) Is there a competitive monopolistic/duopolistic environment?
4) How could your current thesis be entirely wrong (write down all reasons)?

Notice the final step is open ended, given that this is a basic guide if you are able to go all the way up to the final step you will be in great shape for interviews and understanding the basics of finance when you hit the ground running. If you’re able to impress with a non-consensus view then you’ll be more than prepared for the future.

With all of that said if you have questions feel free to leave a comment, the next post we will do on WSO will surround standing out as a non-target student after interviewing ~20 non-targets who broke into Wall St.