Sourcing Investment Ideas

Addinator:

Okay, what are your specific areas? Ideally, ones you know at least something about or are interested in learning about. Then get some industry reports and read those. Then start looking at what companies are in said industries. Then download a bunch of 10-k's for each company and read through them. Read earnings call transcripts, or listen to them if you prefer. Then generate a thesis as to why they are whatever they are, what's going to make it go and what the key drivers are of said company going forward.

I'm not an ER guy, so I'm sure someone with more experience can help you further but that's what I did to get started investing and it worked out pretty well. If you want, toss out the areas and maybe you'll get suggestions.

I was part of the research group that worked on FIG for the past two years but I'm looking more at industrial because I find it more interesting. Specially I'm interning in Corp Fin at a manufacturer that's having inventory problems and are spending quite a bit on supply chain optimization consultants and stuff, I'd like to look into this more but I don't really know where to start, typing Supply Chain consultants into Google finance gives me a lot of logistic companies that focus on trucking which isn't what I'm looking for. Yeah I have a handle on what to do once selecting the company I'm just having trouble getting started.

http://seekingalpha.com/

What sort of credit fund? That will help you narrow things down. For example if it's a distressed fund, skip the macro.

+1 on seeking alpha. I love that site, been using it for a real long time. Probably the best site out there for investing ideas. Alphathrottle was great for news but it got closed down for some reason.

You could also try motleyfool.com

OMG MOTLEY FOOL

I've never seen anything worthwhile on SA... Motley fool is even worse. Just run a screen on credits trading at low levels and do some analysis.

And neither of those sites will give you any credit investing ideas

HY corporates are starting to look more attractive... read this article on BB rated debt and run with it.

http://www.bloomberg.com/news/2012-03-21/top-junk-pummels-treasuries-fo…

I would dig a little deeper if your going to pitch CHK or DISH. A couple data points I would be ready to explain and why they make the aforementioned HY debt attractive...

• coverage ratio
• debt to equity
• debt to assets

You could sign up for a guest account on distressed debt investors club and then look at 45 days old ideas..some of them might still be relevant. This would be a particularly good idea if the fund has a value investing philosophy but then be careful because they might realize where you got your ideas from..

One other thought is that five is likely too many to do a good job with them.

Kenny_Powers_CFA:

One other thought is that five is likely too many to do a good job with them.

This. And in all seriousness, Seeking Alpha or just about any other website really isn't going to help you with an idea that will come across as interesting or creative. If it's in Seeking Alpha (or, dear god, in Motley Fool) then it's probably really old news... either way source your own ideas or read stuff like The Economist to give you an idea of macro news and then source for yourself from there. I've never had an idea come directly from someplace else, it's usually just putting together stuff from several sources with your own experience. That way at least you're original.

sumzero

As I said, it could help primarily with the macro reasoning. A quick google brings up this, dated today and yesterday...

http://seekingalpha.com/article/455381-market-tremors-signal-that-somet…

http://seekingalpha.com/article/457491-traders-converting-u-s-bonds-int…

A couple of credit ideas could be derived from both of these pretty easily, obvious caveat being the quality issue I already highlighted.

I take it you are sticking then?

Stop giving bad advice bro

That wasn't advice! That was a reply to you.

The reason why I am coming from this angle is because the OP was saying...

"I thought about The Economist as a bottom up approach, but think a top down would be more efficient."

I was never proposing SA was the best way of generating credit investing ideas, or that a top down approach was the best way to do it. The OP was saying he wanted some sites with investment ideas and macro reasoning, SA is a site that has some investment ideas and macro reasoning, it is pretty well known and probably warranted suggestion. 'www.seekingalpha.com' is the only advice I have given.

The rest of what I have been saying is purely in response to your being derisive about the suggestion of SA, providing only the alternative of 'run a screen and do some analysis'.

I think we are on the same page but at cross purposes.

https://acwcapital.wordpress.com

Everyone is different. Some develop themes and then look for specific companies within that theme . Some run screens with specific parameters. Speaking with analysts and people in the investment community.

Two of my favorite sources for ideas are asking management (I understand most not in the industry people don't have access) who else in the industry they respect, who their stiffest competition is, etc. and understanding industry verticals and who benefits from larger players doing well/industry structural shifts. For example, if Boeing and Airbus win huge orders TransDigm will benefit since they manufacturer smaller parts on planes (e.g. seat belts, toilets).

I actively follow several subsectors and companies within those subsectors. I always have to be on top of what's going on for all those companies -- as you continue this process, add in new companies, over time the ideas just start coming naturally, and most usefully, they tend to be ideas that are not being followed by the rest of the hedge fund crowd.

Aspharagus is correct, I spend time reading ideas on the listed sites, but some have bs ideas like SA. I usually check my surroundings and see if there is something I like or catches my attention, I then try to research that industry for investments ideas.

From a top-down perspective when it comes to equities, reading a ton of news helps. You start seeing themes emerge and think about the best way to bet on/against these things. Screens also help as mentioned above. A stock or sector will break or rally hard and when looking into why a trade idea could start crystallizing.

Most analysis on SA is pretty terrible. Some articles might be worthwhile (I've published a few pieces there) but you'll realize that there are a lot of vested interests in any stock that is pitched if you read the comments sections (although some insights are pretty good there too). As an example I outlined the long case for a sector on SA last year but singled out one stock as the perfect short if things didn't pan out. The comment section was full of vehement statements in defense of that stock. It dropped 50% over the next 4 weeks.

I would only recommend SA as a way of seeing what others think is driving a stock you are interested in.

For me, two ways -

1. Observational - Sourcing ideas by going to places and living life. Example: the other day, I went to see a movie with a friend. The whole time during the movie, I was thinking how great movie theaters must be as investments. They're regional monopolies and people are always going to be watching movies. There may be some underlying property value if the location is not leased. First thing I did when I came home was seeing if the theater company was publicly traded and indeed it was...but the price was not right. But, if the price for some reason drops in the future, I'll be doing more research.

2. My PMs gives me names that they source somehow. I guess they're just observant and/or know people in the business world.

most L/S equity guys just ask their L/S equity friends what they like.

"Yo what's good?" "Buy some VRX man, it's working, roll-up! CEO is a stud!" "Aight dude, you gave me VRX, I'll give you HTZ! blown up now but industry consolidation happening man! pricing story!" "Thanks bro!"

6 months later, both these crowded ideas blow up.

Consolidating Industries:

Consolidating industries tend to catch my attention so when I read that Blizzard and Activision were merging my immediate reaction was to ask myself how the other players might react. EA has an acquisitive history so maybe the 800 pound gorilla will respond with their own moves. I don't like own the consolidator so I start to sniff around and see if there were any good small names to own that might be taken out. This leads me to identify Take-Two Interactive (the makers of Grand Theft Auto). Before you know it, EA announces a hostile bid for Take Two. Boom. Profit.

Fast forward to today and we are seeing another interesting situation brewing in the space. Big media players have begun to take an interest in video game publishers with Time Warner even publicly stating their interest. EA has been battered and is restructuring to focus on its core properties. I love this type of situation. Companies with great core businesses tend to waste the money generated from their cash cow on dumb acquisitions and a bloated cost structure. So when a business like this finally decides to be more disciplined with their capital, they tend to generate outsized returns. On the flip side, if they continue to struggle/waste money, there are strategic buyers out there who would love to own the company (limits the downside risk a bit).

Capital Allocation:

The market has a tendency to penalize the valuation (i.e. multiple compression, lagging peer performance, etc.) of companies who have an undisciplined approach to their capital allocation strategy.

Prioritizing the Proxy:

1. Compensation hurdle - What metric(s) is the CEO being paid on? I've seen the metric jump around to suit a CEOs strategy or maximize the liklihood of getting paid. I've also seen useless metrics like being paid on non-GAAP operating income dollar growth. You could essentially buy all sorts of terrible businesses, destroy shareholder value, and still get paid. Normally, I would like comp to be tied to some sort of ROIC metric, but it depends on the industry. At the end of the day, I don't want metrics that incentivize people to take excessive risks.

2. Director compensation & composition - I want to know how entrenched is management. I want to know how many board members are ex-employees, dinosaurs (been on the board for decades), professional directors (people who are on multiple boards and appear to make a living as a director), and college buddies of the CEO. I also want to see if they have someone familiar with capital allocation on the board.

3. Peer group - Every company discloses who their compensation peer group is. Has that group changed and is it a reasonable peer group.

4. Options/RSU grants - How is the CEO getting paid. Is vesting tied to perfomance or time? Have they been consistent in the way they value the grants and the type of awards given out? Are the grants consistently done around the same time of year? Has management exercised many options before their expiration? I don't like seeing drastic changes in long term comp (i.e. from granting RSU to Options when the stock tanks).

5. Audit fees

Sizing Positions in the Portfolio & Research Process:

I personally can't get comfortable with investing until I at least read the most recent proxy, 10k, and all transcripts for the last 3 or so years.

I'm ok with having a toehold position based on "initial" research findings if I have prior familiarity with the industry. There have been a handful of times where I definitely recommended positions under the circumstances mentioned above, but it was always due to having high conviction on a macro event that would be an industry wide catalyst and company agnostic...which more often than not, takes more research time.

I've been trained to be thorough and for good reason. When sh!t hits the fan (and boy has it hit the fan the past few months), you need to know how to react. Is the move overdone and worth putting more money into? Or does it confirm one of your "bear case" risk factors and sell? these inflection points are when you either make most of your money or get cut trying to catch a falling knife.

With all that in mind, I'd be fired if I wasn't thorough lol. More often than not, I'm dealing with >$100 million positions and the investor is generously paying 2 and 20. Lets just say I'm more than happy to suck it up and spend an extra few weeks reading/researching to get it right.

Random thoughts during 2009:

1. Starting to see some consolidation but most managers have no financial incentive to sell. Many of these guys have seen their in-the-money options go from $50 million to $5 million in the past 12 months. They would rather sit tight than sell out.

2. Managers will begin asking for a lot more options this proxy season to "remedy" this "out-the-money" reality.

3. A lot of the fat in corporate America is getting cut aggressively...it's like a fat guy realizing he has to hunt for his own food now and needs to get into fighting shape. You usually only see this level of cost cutting aggressiveness after an LBO/Merger. I have a mixed view on this. Some companies should just put themselves up for sale and let the acquirer realize the synergies. Others I'm hopeful but realize management will be tempted to continue their dilutive spending habits when things recover. And for some, the cuts are too little, too late.

4. I still don't understand why some equities are rallying when their underlying debt is still trading a junk.

My view on value:

I have a pretty simple view on value.

1. Value is driven by the returns you generate. For every dollar spent, how much are you getting back? I'm sure you've done those theoretical exercises that show the relationship between implied multiple and returns. Companies with top returns command premium multiples.

2. The market is going to value a company at the returns generated by management decisions/strategies. It doesn't matter if the asset is capable of generating higher returns. The market is going to value the company at management's return and not the asset's return potential.

3. Find situations where management/company returns are significantly below the intrinsic return potential of the asset, and a catalyst exists to close that gap (assuming you want to go long).

Real example:

Company with a history of high return on capital brings in a new CEO who decides to spearhead a new initiative to aggressively grow revenue and EPS. A part of this strategy entails entering businesses that have high growth, but low return on capital (i.e. much more competitive business). To make matters worse, the CEO acquires into this business and further dilutes returns when including goodwill.

Although the company experiences revenue and EPS growth from this strategy, the stock price lags peers and the multiple contracts (for this examples lets say it went from 17x to 13x). The market was now valuing the company at management's new return rate and not the high returns of the core asset. This made sense because CEO compensation was structured in a way that incentivized this behavior and there was no indication the strategy was going to change.

Fast forward and I come into this situation after the CEO leaves and a new CEO is brought in to focus on the core business. The catalyst for me was the exit of the low return business. By freeing up the dollars that would have otherwise subsidized the other business (working capital/capex needs, etc.), the company was now 50% undervalued. This didn't even include the potential multiple expansion attributed to improving returns and emphasizing a return based capital allocation strategy (a portion of the new CEO's compensation was tied to return on capital).

Result: Multiple expands back to 17.0x and stock doubles over a couple years.

Why multiples vary:

Why multiples vary between industries and over time:

For the benefit of everyone new to this stuff, I'm going to start with the basics and work my way towards explaining (or at least try to) why multiples vary. Please bear with me if this post comes off as "multiples for dummies". I found that this is the easiest way to learn this concept.

I. Drivers of Value

We already know that the theoretically "correct" way to value a firm is to take the present value of all future free cash flows. At its most basic level, value is future cash-on-cash returns (i.e. how many dollars am I getting back for every dollar I spend) So with that in mind, valuation (and multiples) are driven by three things:

1. Growth
2. Returns
3. Required rate of return/discount rate

Growth and returns drive the numerator of the DCF, and required rate of return drives the denominator. (I know...duh)

II. Growth

For the most part, growth is good. Just don't fall in love with it. Most people get tripped up on growth because they forget to account for the capital intensity required to drive incremental growth. Remember, valuation is driven by "FREE" cash flow so even if you're growing like a weed it won't do anything for your valuation if it requires spending an excessive amount of capital to get you there (i.e. you're incrementally spending more dollars for every additional dollar generated...in other words, you're killing your returns).

III. Returns

Returns are the biggest driver of value. When you see material changes in valuation/multiple, it is usually the result of changes in returns. Most of the value created in Private Equity is driven by improving an asset's returns (i.e. cutting bloated cost structure, disciplined capital allocation, etc.)

IV. Required rate of return

Not really relevant for this discussion, but it is helpful to see what the market is implying given an asset's growth-return characteristics. The key to good investing is to risk adjust the required rate of return. For instance, say you come across an asset that is trading at 5.0x. Assuming no growth, that implies the required rate of return is approximately 20%. Determining whether that 20% is properly risked is how you generate your alpha. If the discount rate is the result of a forced seller, you probably have a good buy on your hands. If the asset is eroding, you might be overpaying at 20%.

V. Multiples

Mathematically, multiples serve as a close substitute to the DCF. In practice, most investors use multiples as a shortcut to DCFs, because they are simple to do and easier to compare with other assets. Done right, using the multiple approach can effectively replicate the results of using the more theoretically correct (and usually more complex/time consuming) DCF.

Using the Gordon Growth Valuation Model as a framework, the multiple (in this case forward P/E) is calculated as:

Forward P/E = (1-(Growth/ROE))/(Required Return - Growth)

In essence, multiples are a reflection of the growth, return, and risk profile of industries/sectors.

Investing with a catalyst:

Always remember that you can lose a lot of money even when your thesis is correct (in the long-run). On the flip side, you can make a lot of money and be completely wrong in your thinking. So what are the main takeaways?

1. Always ask yourself "What's the catalyst? And what's the timeline?" when investing (or pitching) anything. An asset's price can stagnate for months/years without a catalyst, but prices move very quickly once a catalyst is a achieved/reached.

2. Even if you have a long investment horizon, you still have to deal with annual "checkpoints" where investors evaluate your progress. You might have all the tools to win the marathon, but your investors might pull you off the course early in the race if your pace is too slow.

3. If you don't know the timing of your catalyst (i.e. shorting a bubble), but still believe in the thesis, try to find "cheap options" and hope you can buy them. Google: Paulson, CDS, Subprime

This is good stuff. Thanks Mr. PM

Great write-ups, hope to see some new ones soon!

Hey man, 3.5 years late but awesome write ups. I really appreciate them and I'd give you an SB if I had one.

Are you asking how to be an analyst? And if you're already an analyst, didn't you receive some sort of formal training? Not trying to shit on your parade, mate, but you might be in the wrong business.

http://www.wallstreetoasis.com/forums/idea-generation-and-why-wall-stre…

Think this has been discussed to some extent in these forums before. The answer is "it depends." I think my shop is a bit unique in the sense that there is no structured rule that calls for analysts to pitch ideas on a daily/weekly/monthly basis; however, we hold regular investment committee meetings and it's implicitly known when someone hasn't brought a (good) idea to committee in awhile, which could obviously affect credibility, reputation, and comp. I make it a personal goal to pitch one well-researched idea a month (thus, the answer to your other question is I spend a few weeks on a name). My buddies at other shops have completely different experiences. One has to either provide a portfolio update or pitch a new idea every other day. Again, the answer is it depends.

One thing I will say is that there is a certain expectation at a HF to always have an actionable high conviction trade idea ready to talk about at anytime.

As above user said, I think it depends (and I would agree w/ everything he said). I don't know a fund that expects a person to pitch 1 idea every X time, but from what I understand you usually want at least 4 very good ideas per year (usually not more than 6, because then they're either not "high conviction" ideas or you're a legend) and roooooughly ~1 idea a month. I think there was actually something in one of omega advisor's presentations (within past year).

http://www.businessinsider.com/leon-cooperman-hiring-analysts-2012-9

However, it is worth reiterating some funds are shorter-term focus so they want you to have an opinion on a new name every week and on every earnings you cover.

What has been said above. For me about once a month.

.. wrong thread

Since you say you are new to the industry, I assume that means you have just started working at a new job. Let me preface this by first saying I do not work at a hedge fund, however, I know a number of people who do (mainly fundamental value/long short equity shops) and from what I have heard, a junior level analyst is usually not expected to generate investment ideas right from the start. Generally, you are considered "dead weight" in your first year, so what you need to do is stay in "sponge" mode and try to absorb and learn as much as you can.

"formulating a comprehensive logic chain"???