Revenue and Cost drivers in model?
I am doing a take-home case study and wanted to understand what level of granular revenue and cost drivers should I make? This is for a tech company, so typical p x q is difficult for revenue drivers and I don't want to rely on mgmt guidance (probably could look at actual results vs guidance historically) but what else?
For cost drivers, biggest expense is people cost but how do you get any level of granularity on what they plan to spend?
What you are aiming to do is find dispersion versus street. You are not trying to out-model the CFO of the company. They obviously have far more information than you, and will be able to model the company and provide guidance based on their own internal company model which again, has far more detail than you have. So assume that the guidance embeds the base case scenario (with a potential sandbag which you can gauge based off historical beat / raise cadence), and then from there you’re trying to find key points that have changed since they issued guidance.
Has the IT spending environment improved or deprecated since they issued guidance? Add some upside or downside into the model. Do they have a new product that you think can layer into the model over time and add to revenue growth and margins? Do the back of the envelope math and layer that in. Has a key cost driver for the company changed since they issued guidance (memory prices for example)? Add some margin headwinds or tailwinds. What about orders from AI? Add those in as revenue upside on top of base case.
The goal is not to model the company to hyper accuracy, the goal is to take a reasonable over / under for the business. If your revenue beats going forward are far higher than management’s historical beats, you should have a good reason for why that is the case. Same with the opposite, if you have them missing a ton. Additionally, if the company never misses the quarterly revenue guide, you know that you need to focus far more on the next quarter’s revenue guide as opposed to what they’re going to print in quarter, as you know based on history the CFO is competent in modeling the quarter.
In summary, it’s not about finding alpha in the model through some deep analysis of minutiae in filings or something (this can actually happen but it’s just rare), or the average investor mis-modeling the company (street can sometimes do this though). It’s far more about taking a view on the company, not the model, and then expressing that view of the company in your model with financials that are underwritten with data.
This is very helpful. I’m prepping for L/S interview long pitch; even if I know the company & industry intimately, it seems highly improbable that I can find any sort of differentiated view that’s wildly different from sell-side estimates.
For example for a software co., unless I have a real information edge, who am I to say that they will print +15% new logo growth next quarter vs +10% street consensus? Essentially my job is to find enough info & data to I can say with [90%] confidence that they will beat consensus by 5%?
Coming from private equity, it was easy to make that assumption given we can control it but I’m having a hard time to determine that level of confidence given I don’t really have any information or operational edge.
Also, is that theoretical 5% enough to be a strong thesis / variant view?
This is very helpful indeed. How much of the differentiated view in what you are describing is driven by hard evidence versus hypothesizing rationally about the company's fundamentals based on your understanding of the business? I'd imagine it's a combo of both and it depends on what resources you have access to. If so, what would you say the split is 50-50? I'm not doing a case study but very curios about your thoughts nonetheless
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