Hedge Fund Folks: How do you “spread numbers”?
What are folks’ processes for spreading a company’s numbers efficiently? Have recently moved into a single manager hedge fund seat from PE and have had some difficulty adjusting to the pace of work and often spend multiple hours just laying out company numbers.
Anyone have tips to reduce the time spent on this lower value add (and monotonous) activity? Are people pulling from Bloomberg? Taking from equity research? How do you get segment level financials? How far back are you usually pulling?
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Bump as I’m interested in other folks’ process.
I have an excel template that I’m tweaking as I go to make it better, but generally I’m capturing the following. Note that I mostly look at credit and almost never normal equity - so EPS drivers are less meaningful to me (share count, GAAP net income, etc).
Volume, price, revenue (often by segment), gross margin, sga, and down to EBITDA on the I/S. I try to separate out what seems fixed vs. variable in the cost lines. If high fixed cost structure, I try to see incremental/decremental margins to triangulate what might be happening to earnings in an upcycle vs. downcycle.
Then move down to CFS by netting EBITDA to capex, interest, tax, NWC change. I use CFFO - Capex definition as my FCF and let the balance be “Other Items”. If this Other line is consistently large or volatile, I investigate. I usually have line for EBITDA less Capex just to see the “clean” unlevered FCF/run-rate EBIT proxy. I also note Acquisitions cash flows if it is an M&A active business to later go back and approximate returns on historical investments.
Then I spread the B/S with key line items like cash, AR, Inventory, PPE on asset side and AP, Debt, Pension on liabilities side, and maybe a few other factors depending on business. If not a standard widget business, there could be others important to monitor (e.g. contract assets/liabilities, deferred revenue, etc). Then I calculate days sales, days inventory, days payable to see the cash cycle.
I always lay out a debt schedule separated by tranches. And I note liquidity based on revolver capacity and other capital sources available to the company - this is usually not that revealing in historical context, but you may learn something about seasonality of cash flows and how the company typically deals with tight liquidity.
At this point, I’ve probably spent an hour or so in the company’s financials. Typically 3-5 year annuals and 6-8 quarters. This process gives me a good line of sight to model questions I need answers to from management. And some key analysis output around what type of sensitivity I need to test on forward earnings power to get tight on my valuation assumptions.
Welcome anyone’s input or if others have pointers on how to do it differently
Also a credit guy and was going to write almost word for word the way this guy does it. I will usually do the last three years annual and last two years quarterly building to LTM.
One thing I like to do break out the CFS a little more granular below the Free Cash Flow line item. For Free Cash Flow, I personally like to calculate as EBITDA les interest, tax, NWC change, capex and compare to straight CFFO - Capex to see if there is any discrepancy for some reason. Below Free Cash Flow I break out line items for asset sales, acquisitions, debt and equity issuances / (repayments and repurchase) and plug with an "Other" line item. If I do this right, "Other" should be very small and if not it is something to investigate. I prefer to break out so much below FCF because, particularly in distressed / stressed credits, I like to see what levers the Company is pulling to manage their liquidity. FCF burn can only go on for so long if you are keeping net cash flat or growing by executing asset sales. If an asset sale heavy company, are EBITDA margins improving sequentially / annually if they are selling non-core / underperforming assets? Or are margins shrinking indicating they could be selling the furniture to keep the lights on? A serial issuer of debt or equity can get in trouble real quick when the market pukes and probably one of the more important line items I scrutinize. Also, I know it is a pain, but building your CFS quarterly is a huge help and eventually you can get quick at it.
Working capital dynamics are also very important. I like to spread quarterly and calculate cash conversion cycle via DSO, DIO, DPO etc. I will go an extra step and build in some dynamics to the working capital schedule so I can see what the cash benefit may be by stretching your payables a few days or getting a little better with inventory. Sometimes there can be a meaningful cash benefit sitting right in front of you if working capital management improved.
i've seen some PMs at prior shops that never tie EBITDA - cash adjustments - capex - NWC - interest - taxes to actual CFO - Capex. Has anyone else noticed that being common?
Also - do you guys tie down cash taxes as (IS tax # +/- deferred taxes on OCF, and maybe taxes payable if broken out in the NWC section of OCF) or just use the supplemental cash taxes paid #? I notice when there's a big "other" discrepancy that causes EBITDA walk vs. OCF-Capex to not match, it often relates to taxes just being improperly prescribed in the supplemental cash flows.
I pull numbers from a sell side analyst that I trust and spend a few minutes to make sure it ties to latest filing. Canalyst is a good resource too. Unlike PE, it isn’t worth spending hours spreading financials unless the idea is clearly very actionable.
how do you quickly determine whether an idea's actionable?
1) Understand high level business model and relevant metrics such as free cash flow, leverage, capital structure layout, etc.
2) Assess the current situation and what the "problem is".
3) Determine whether or not the problem is solvable, what instruments are available to execute, and rough catalyst time frame.
4) "Back of the envelope" return profile to see if risk / reward makes sense.
Most situations can be ran through this triage in under a few hours.
following
basically i type in one year of financials and then copy paste the rest from sell side. I don't waste my time on cash flows just try to get to UFCF by doing ebitda - cap ex - nwc - tax
For the 'screening' / 'idea generation' phase where I'm spending a day or two on something -> go onto a platform like Visible Alpha, pull 5-6 models from different brokers then find the simplest / most intuitive one and start playing around with that to see what need to go right / wrong to get a big beat or miss vs consensus a few years out.
When moving onto the 'real research' stage (i.e. after I've pitched the rough idea to my PM and they're keen for us to do the work on it) I'll always build something from scratch and populate historics back over at least one full economic cycle. I don't like templates for several reasons:
- I'm a generalist not sector specialist, so building templates that would be useful for every type of company I look at would be too time consuming.
- Templates generally don't pick up all the KPIs the company & sell side care about and which move the shares.
- Every company defines things differently and you can completely miss these if you just refresh a template.
- Depending on what my thesis is I'm going to make my model more or less detailed in certain areas. If I'm looking at a super cash generative company without any significant leverage, I'm not going to waste time building out a debt schedule.
I have a completely different approach to these two 'phases' because I'll screen dozens of ideas a year in the 'idea generation' phase, and will do full work on only a small handful of these (definitely less than 10). You might not have that luxury at some funds running a higher turnover strategy or where you have sector coverage and need to have a view on everything within a defined universe of companies.
Without spilling any operational alphas:
1) get down to unit economics
2) analyze cost structure
3) tie trends in margins to strategy (guidance and comments)
4) build pro forma on guidance and then add in your overlays (and comparison to street)
Public equity investing/trading is different than PE. At a hedge fund, you typically are straddling the roles of a speculator and an investor. So what's more important than having a wizzy model is having a model that you know your downstream (future buyers) will use. Value is useless if you are the only one who can spot it.
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