PE Interview Question - what would you invest in?

I was just asked, “what would you invest in right now?” during an interview for a PE firm. It’s a very open ended question and was just wondering how any of you would answer it.

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What level position were you interviewing for? If you have been in finance for a few years you should have had an opportunity to develop an opinion and perspective regarding what you consider to be a good investment relative to the macro backdrop. There is obviously no "right" answer to the question but your answer should have touched upon key points such as European crisis, US housing/unemployment and then gotten more granular to a particular industry and series of companies that you think are good investment candidates. i.e. Given the uncertainty in Europe and the global banking industry I would stay away from bank stocks in the near term (unless you want to go contrarion and argue that there is value in names like JPM/GS/BAC) and would instead focus on defensive names and non-discretionary names that offer predictable cash flows and solid balance sheets. Whatever name you choose you want to ensure to highlightthe following (all characteristics of a good LBO target): - steady and predictable cash flows, which will allow for optimal financing terms and interest coverage - asset rich - to provide loan collateral, downside protection and offer an opportunity to sell to raise cash and pay down debt - clean balance sheet with plenty of cash and little debt - minimal capex and working capital requirements - expense and synergy opportunities

I can think of a few names that all fit the bill but I would rather not since some of them are live

 

This question should be a slam dunk, and be one that you definetly need to have a well thought out response to. As an interviewer, I ask this one all the time, and its usually the first one I ask.

In terms of an approach, start with a macro overlay by describing the current economic environment; uncertainty and limited growth in Europe, high unemployment in the U.S. but consumer spending still strong and certain indicators starting to point positive (use this as an opportunity to fire off some facts that you recent read in the WSJ - new housing starts are up, Q4 GDP growth projected to be strong, manufacturing still looks good, consumer spending really strong over the holidays). Caveat this with uncertainty over the political and regulatory environment, so there are risks, but we've narrowed it down to the U.S.

Then in terms of what sector/industry? Pick one that isnt entirely reliant on the macro environment, one where you aren't banking on a cyclical rebound (these investments are fine in moderation, but I wouldnt pitch it as my only one). I'd go with Business Services or IT - Software that is addressing a disruptive shift in the market. The explosion of data has created a lot of opportunity for growth-type companies to track/store/ and analyze data. Or the movement to the cloud and virtualization have created a lot of opportunity as well. These types of companies who are able to effectively address these trends are exposed to organic growth rates driven by IT spend in the high single digits, regardless of macro trends. IT departments are also increasingly becoming more comfortable in outsourcing these services. Know though that multiples in this space are very frothy right now, so finding the right company will be a challenge; there is a lot of capital chasing these companies right now.

Then take it to the individual company level: - High component of recurring revenue for downside protection, sticky customer relationships, viable exit opportuity (is there a market for this company?), customer concentration, market position/competition. All important questions, but for a growth IT Software company, the biggest question is, what will it take to generate growth from here? Geographic expansion, new product rollout, bolt-on acquisitions, or just organic growth? These are all different risk profiles and need to be addressed. I wouldnt be that concerned in finding an actual company, but being able to articulate the above is important.

Also, be able to identify a sector that you wouldnt want to invest in today.

 
CREAM:
I was just asked, “what would you invest in right now?” during an interview for a PE firm. It’s a very open ended question and was just wondering how any of you would answer it.

The two posts above are spot on. One thing I'd add is that you should steer clear from the same industry that you cover in IB. As an interviewer, I'm probably going to talk to you about your deals, so I'll get a sense of whether you understand the industry through that conversation.

When a FIG Analyst starts telling me that insurance companies are the best investment, it just makes me think they lack creativity and are just regurgitating whatever they have heard their MD talking about recently.

 

Great responses and thanks for the feedback. It was just for an analyst position.

I followed a similar approach to the first two responses. After I was finished my response, the interviewer just looked at me and said, "CASH". He defended his view and I defended mine, we just had different investment approaches.

 

if you can't answer these questions off the top of your head, you don't deserve a job at a good fund...

in short, know macro, know industry, know valuation, have a thesis....

these questions are not suppose to test you how well you prepared or memorized shit from WSO , but your investment acumen....

hope this helps you not in this interview but in your approach going forward.....

 
bunkerbanker:
if you can't answer these questions off the top of your head, you don't deserve a job at a good fund...

in short, know macro, know industry, know valuation, have a thesis....

these questions are not suppose to test you how well you prepared or memorized shit from WSO , but your investment acumen....

hope this helps you not in this interview but in your approach going forward.....

I certainly haven't "memorized shit" on wso - I don't know why I've given you this impression, but I have actually taken time to understand valuation and why something is done (not just the formulas itself, but context of it), practiced how to put together models from scratch, read the news on private equity, etc. But investment acumen I believe is something people do have to take time to learn, and is not something you pick up in your day-to-day work such as investment banking. So that is why I posed the question here.

 

The "what would you invest in" is one of my favorite go to questions given how poorly most kids answer.

First of all, if you tell me you want to invest in one of the companies your MD covers or some company you worked on the capital markets deal for, I'm going to puke. Be creative and look outside your coverage group.

Secondly, if you name a company, you better be able to tell me exactly how they generate cash, what the growth strategy is, available leverage, etc. And then why this company is better than its peers.

 
BananaStand:
The "what would you invest in" is one of my favorite go to questions given how poorly most kids answer.

First of all, if you tell me you want to invest in one of the companies your MD covers or some company you worked on the capital markets deal for, I'm going to puke. Be creative and look outside your coverage group.

Secondly, if you name a company, you better be able to tell me exactly how they generate cash, what the growth strategy is, available leverage, etc. And then why this company is better than its peers.

Thanks BananaStand. I actually don't work in IB, so I don't have coverage companies to depend on, so that's done. I guess right now is the process of finding a company. I have some industries in mind, so maybe I can start a capIQ search and do some research today.

It seems though that even those who work at funds, are often approach by companies themselves, or introduced at a bank. How often would a PE shop actually source a company from scratch and approach them?

 
Marcus_Halberstram:
The ones getting the offers did pick it up from the day to day in banking.

Just saying.

Well good for them, I guess. Right now I am competing with those with more traditional backgrounds. So I hope that I can learn to think more like an investor, as a way to stand out. But beyond focusing on what I can do to better my chances, everything else is out of my hands.

 

Dude... this is how I would think about it... What are the key themes that are the driving force in the world today. Off the top of my mind, I can think of the aging population, growth of em middle class, infrastructure needs etc. Then pick an industry you are interested and think sectors/subsectors that can address these themes... then do a broad scan of the companies within the subsector... immediately cross off the ones that don't make sense (high multiple, ownership, whatever the fuck you wanna make up to not look at a company). then pick 3 or 4 and study the shit out of them, know everything, rationale, risks (on industry, company and transaction level), historical segment financials memorized, actionability, grow ops, then pick 1 out of the 3 or 4 that you think stands out to pitch..,then look at a precedent in the same subsector, compare and contrast, know the same things i just listed... know why its successful not sucessful, create a 10 page case study..

the point is, you are not gonna find an answer on wso from these "pros" with stars. You gotta find the answer yourself through dedication, intellegence and personal interest...

hope that helps....

 
bunkerbanker:
Dude... this is how I would think about it... What are the key themes that are the driving force in the world today. Off the top of my mind, I can think of the aging population, growth of em middle class, infrastructure needs etc. Then pick an industry you are interested and think sectors/subsectors that can address these themes... then do a broad scan of the companies within the subsector... immediately cross off the ones that don't make sense (high multiple, ownership, whatever the fuck you wanna make up to not look at a company). then pick 3 or 4 and study the shit out of them, know everything, rationale, risks (on industry, company and transaction level), historical segment financials memorized, actionability, grow ops, then pick 1 out of the 3 or 4 that you think stands out to pitch..,then look at a precedent in the same subsector, compare and contrast, know the same things i just listed... know why its successful not sucessful, create a 10 page case study..

the point is, you are not gonna find an answer on wso from these "pros" with stars. You gotta find the answer yourself through dedication, intellegence and personal interest...

hope that helps....

Thanks bunker, much appreciated.

 

Ahh, didnt know you're not coming from banking. The more traditional background for PE IS banking, so you have the non-traditional background.

That basically means you need to demonstrate you "get it" despite not coming from banking... that will be one of the focal points of your interview. Unless of course you're a consultant and interviewing for an operating group.

 
Marcus_Halberstram:
Ahh, didnt know you're not coming from banking. The more traditional background for PE IS banking, so you have the non-traditional background.

That basically means you need to demonstrate you "get it" despite not coming from banking... that will be one of the focal points of your interview. Unless of course you're a consultant and interviewing for an operating group.

Nope, not a consultant either. I think I've mentioned my background on WSO here and there, but just for anonymity sake, I won't repeat it all in one place.

Yup - I already had a previous round where I was asked technicals, and 'why PE' and 'why us'. So at least from an initial technical test, I've proven that I 'get it'. But my next meeting will be with VPs/directors and from prior experience, I'm guessing it's more fit questions (again 'why PE', 'why this firm', 'why you', 'strengths vs. weaknesses', 'why now'...)

...Then probably more case-study type questions like 'How would you evaluate company A vs. B' and the investment question. These are questions I would like to work on this week, though the former is not something I can really prepare for... Maybe it would make sense to splurge on a mock interview w/ WSO...

 

dude energy BC of the crash and burn reputation of oil and steel bc of the riots shit has to be rebuilt + expansion in china etc

except if you said expansion in china i would counter with buildings that have no inhabitants in china

you could then say ,but you believe the Chinese government will need to keep its people employed thus increasing housing and other stuff built from steel ...like the Chinese wanting to build up there naval fleet etc

 

This is tough because 1) if you start to talk too much about what they know well, you will probably fail to impress a bunch of guys/girls who have spent all their time working in one sector. Secondly, if you pick something completely off the beaten path (although it might be a great place to invest), you might be viewed as someone who didn't look at their website. I'd focus on an area that you know well and go from there. You could probably find some trading comparables just to know where general industries are trading as far as multiples go. Things are definitely turning around but a lot of PE shops are still sitting on the sidelines, playing a game of chicken.

The issue is that the cap markets have opened back up to companies in a big way so finding money is not as hard as it was back in '08/'09. Before, it was slightly easier to find a bigger, well-known company who was undercapitalized (and who could not access the equity nor debt markets) and maybe wanted a financial partner.

Finally, I'd see what kind of areas/sectors the firm has invested in previously. One piece of advice I got when I was interviewing was to see why certain deals in a company's portfolio makes sense (i.e. bigger platform? investing across industry value chain? etc.). They're not looking for you to source a deal for them (i.e. they will not come out and be like "oh. wow, let's look into that company Kanon mentioned..") but rather, looking for you to understand the big picture.

 

It's a pretty dick move IMO to ask "what would you invest in?" for a PE interview, knowing that most candidates work a 100 hours per week in a very specific industry where the work is usually not related to the markets. These aren't interviews for hedge funds...PE firms don't think about where they want to invest and then go buy shares. They get CIMs, they hear about opportunities...and then they decide whether they like them.

With that said, its perfectly normal for them to GIVE you a hypothetical company and then have you run through a case study and analyze the growth drivers, which always takes some creativity, and then give your opinion on whether you like the industry (and keep in mind you can always "like" an industry for the right price). I find with these case studies its always helpful for me to figure out what the end products for consumption are and start with demand for those then work my way back up the supply chain to what the company does. I'm looking for recurring revenues (aftermarket and installed base is a huge plus), strong competitive position and end market demand that won't go away in the near future.

 
HireUp212:
It's a pretty dick move IMO to ask "what would you invest in?" for a PE interview, knowing that most candidates work a 100 hours per week in a very specific industry where the work is usually not related to the markets. These aren't interviews for hedge funds...PE firms don't think about where they want to invest and then go buy shares. They get CIMs, they hear about opportunities...and then they decide whether they like them.

Its a dick move to ask a candidate who is interviewing for a position where they'll be choosing companies to invest in to communicate a view on choosing a company they should invest in? Seriously?

Where did JCrew come from? JoAnne Stores? DelMonte? FirstData? SunGard? TXU? Let alone the swarms of PE shops that typically aren't thrilled about buying widely shopped businesses.

The point of this question is to identify your investment accumen and your understanding of the PE business model. What does an attractive business look like? And whats an example of one of these?

 

Good way to start answering this question is by researching the firm's investment style. This can begin with sector, as many firms only focus on certain spaces. For generalist firms, many specifically state that they simply look for dominant players in the target space. It probably also makes sense to look at a company with a captive audience, so that you have pricing power. If you're interviewing with a growth investment firm, you might suggest that a company likely to gain a large amount of market share (or be a growth leader in a burgeoning market) in the near future would deserve a good look. If you're interviewing with a firm that prospects for more mature companies, suggest a company with a proven and defensible business model that has produced and will produce stable cash flows going forward.

It's always good sense to buy in low. Also take the macro environment into consideration. While it's true that many firms like to play in spaces that they believe are recession-proof, this doesn't always work out (see HET.. not hugely successful). It's probably worthwhile to mention what's going on in the world. If you believe, like many in our world, that inflation is coming hard and fast in the near future, then it might make sense to look into asset-heavy businesses in a rising price environment, especially given temporary tax breaks for hard asset purchases put in place by various stimulus measures (cheap expansion).

There really is no single right answer, but this is how I'd start to think about it.

 

You would need to give out more answers. First you gotta decipher which is the better business ie. which ones has the best competitive advantage? - is one the lowest cost producer, best brand/customer loyalty? best/most patents? idk which business is better.

Second comes down to valuation. Think about maybe a year ago. Looking at the three US telecoms, Sprint, Verizon and AT&T. I would argue Sprint had the worst business, but they made the best investment since the had the best valuation/price in relation to the quality of their business.

Be nice to those in distress, you could just as easily be in their shoes
 

So if you had to pick a company and industry (given free reign), I'd begin by asking yourself what industry is going to grow strongly/stably in the future, and is underpriced right now. Once you figure out a industry or few, you can do some comps analysis to gauge which companies are underpriced compared to its peers. From there, you could do a DCF analysis (with or without synergies) to determine if the companies you picked are good choices. You can graph your results on a "football field" graph.

This is the generic approach I would take.

 

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