HF Analyst - Open to Questions
Longtime reader and new on the board. I know there are a lot of active and great users on here (BlackHat) but I also wanted to pitch. Have been working at a L/S value fund for 3 years - we tend to take very long-term holdings. I'd like to answer any questions people have on coming up with ideas, estimating intrinsic value, and thinking about quality of businesses. I don't really feel like answering any questions on my background or how I got here though.
-David
Thanks for this. What's the max draw-down you'll take on a position given the longer time horizon? How long does the research/diligence process typically take (when vetting new ideas)? What do you find to be your greatest sources of investment ideas?
We don't really have a tradition max draw-down. Mark to market price declines are totally fine so long as our estimates of the company's value haven't changed. I think what is critical is to always be monitoring any self-biases you may have. For example, you may be so in love with the company/position that you are are ignoring data points that point to your original thesis being wrong. If your thesis is wrong, get out. No need to chase sunk capital. If your thesis hasn't changed and the stock price is declining, that's when you generally want to be adding. The investment becomes much less riskier provided something hasn't fundamentally changed to the company's intrinsic value.
Regarding greatest sources of investment ideas, it's really all over the place. Everyone can run the same traditional screens so it's important to know you're not the only one that is stumbling on some company on the list. Generally there is a reason it is on there in the first place. The best way to find new ideas I've found is to just read a ton, talk to people/companies/competitors and just be passionate about what you do.
Hey this is great.
1) How much weight do you put on DCFs for intrinsic value, if not a lot, what are your most preferred methods of estimating intrinsic value?
2) Where do you focus your attention to mostly when deciding on potential future catalysts, and how do you price them in?
Thanks
In my mind, I much prefer an IRR in framing intrinsic value. A quick IRR is taking the FCF yield plus the long-term growth in FCF. If a company is trading at a 14% FCF yield and you believe FCF will grow 3% over the long-term, you're getting a 17% IRR, much higher than the market. That way, you're valuing things without baking in multiple expansion - if it happens, awesome.
DCFs have always struck me as being pretty silly. I'm also of the belief that different people have different 'discount rates'. If you're trying to consistently get a 20% return, your cost of capital should be 20%. If your satisfied with 8%, then your cost of capital should be 8%. All I'm getting at is that certain people discount cash flows differently.
We look at soft and hard catalysts. Some catalysts can just be capital allocation (debt paydown, dividend, repurchases) that creates value for shareholders. Other hard catalysts such as a spin-off, sale of segment are modeled in but we're not playing for that. We want that to be a call option.
Agree very much with your view on IRR over the traditional DCF method. Thanks for answering questions.
What range of IRRs do you look at before pursuing an investment? 15%, 20%, 25%? Assume today's market environment.
How do you think about the following two scenarios: 1) a stock with a high equity IRR but no good catalysts, and 2) a stock with a mid-to-high IRR and some catalysts.
Could you touch on some instances when you have run into trouble using IRR as a main measure of valuation, and in those instances, what you did as an alternative? For example, distressed companies, very minimal FCFE, etc.
When you have an IRR, do you consider there to be a separate "market cost of equity", and if so, in what ways, if any, do you go about estimating / calculating it (I will say CAPM solely as an example)?
Looking forward to reading your responses.
Most preferred methods of valuing a company? Do you cover companies or industries?
I think IRRs are the best way to value a company. I cover both companies and industries, but there are a few industries I refuse to touch. Those are mostly financial and healthcare related.
Like @baystcheese 's question - any advice on modeling potential catalysts to estimate intrinsic value? (e.g. - modeling an oil company spinning-off it's midstream assets, modeling a company spinning off timber assets into a separate REIT entity, etc.) - Any knowledge or resources (books, etc.) that you can share on this topic are greatly appreciated. Thanks!
Really depends on capital allocation and business quality.
Good question TooShort. I think in this environment, a 15% post-tax return is attractive if you can get it. Depends on the no good catalysts- if they're buying back stock that could be good enough for me. Catalysts are nice because they shorten the expected time horizon for that value gap to close + could get faster multiple expansion --> higher time-weighted IRR.
I don't do anything for coming up with a market cost of equity. I think of it as my cost of equity. I generally want at least 15% returns.
Thanks for posting, +1. So the answer to @"TooShort" 's
is 2) ?
For 2) Not sure entirely what you mean.
Thanks for doing this DBeen123. What advice would you have for someone who's about to start their first analyst stint at a similarly-focused HF? I know that's a pretty generic question, but any insights into how you made sure you hit the ground running three years ago would be much appreciated. Thanks.
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