Equities Analysis: Module 1

​​Hi Everyone!

Welcome to Term 3 of the I4C Trainee Program! We’re so excited to be bringing you a revamped series of learning modules with an objective to give you an introductory taste of equities and stock analysis. The purpose of this semester is not be the ‘all-encompassing, universal’ source but to provide a small stepping stone into this side of finance that not many university students know about.*

We hope you have a fun time learning and working through the case studies and problems. Note that we’ve taken your feedback into account from last semester so please continue to leave comments! Without further ado, let’s start!

* Note: All of the content published on this platform is to be used for educational and informational purposes only and without any sort of advice or warranty insinuated. The materials provided are not, and should not be construed as advice or recommendations regarding the securities outlined. Trading of securities may not be suitable for everyone. In conducting such an act, there is potential for large risks including substantial monetary losses. As a student, you are solely responsible for any losses incurred from stock trading and Investing for Charity is in no way liable whatsoever for any risks incurred by you when making financial decisions or undertaking trading or associated activities.

Expectations for this Semester: What do you want to achieve?

Expectations

 ​Take a moment to think about what you hope to get out of this semester

  1. What are your goals?
  2. Why are you learning about equities?
  3. How can this program help you?

This semester will be much harder work than last semester.

Given the complexity of the concepts, you will need to commit to the program and learning experience. We will work together with more workshops but note that you get out what you put in. Give everything a go – it doesn’t matter if you make mistakes but it does matter if you have not given your best attempt. We encourage you to explore, discuss and try in this environment. It’s a learning experience for everyone.

 We suggest that you write down your goals for this semester before starting the module.

What will we be doing?

At the end of this semester, you will be producing the following:
A. A stock pitch deck: including your recommendation
You want to tell a story about whether or not it’s worth buying in the current market. Don’t feel compelled to make a buy recommendation.
We have provided a list of 10 listed companies which you can select from in your groups. Note that this selection is on a first in first serve basis. If you have another company you would like, please message a director from the Education Team.

  1. Telecommunications – Telstra (ASX: TLS)
  2. Media – Nine Entertainment Company (ASX: NEC)
  3. Online – Seek Limited (ASX: SEK)
  4. Online – REA Group (ASX: REA)
  5. Airlines – Qantas (ASX: QAN)
  6. Consumer Retail – JB Hi-Fi (ASX: JBH)
  7. Consumer Retail – Woolworths (ASX: WOW)
  8. Healthcare – Cochlear (ASX: COH)
  9. Healthcare – Primary Health Care Limited (ASX: PRY)
  10. Property – Lendlease Group (ASX: LLC)

B. In-depth initiation report
There are many different types of research reports. When an analyst launches coverage on a stock, they will write an in-depth 101 analysis on everything and anything related to that topic. This is called an initiation report and will be the main focus of this semester’s topic.
As an analogy, it’s the “birth certificate” of the stock under their universe of stock coverage. You will write a similar document that has industry research and data and guides people on this. Watch the video below and check out the examples:

How can you be on top of new information + explore this interest for your career?

A. Read the news EVERY DAY (AFR, SMH, Wall Street Journal) and follow stocks

During our F2F workshops, we will spend 10 minutes discussing the news and running through Q&A per person. Yes, it’s a lot of pressure but will help you get up to speed with thinking on the spot. We’re not out to “get you”, we want to help you improve. (Bulge bracket securities interns (esp in NY) have been reported to get their interns in a room to stand up every week and pitch an idea and face questions and answers). We encourage you to think critically about the news you hear and the flow on effects on industry, your stock, competitors and the market in general

UNSW Library also has a subscription to AFR. Just search for the Australian Financial Review on UNSW Library and login with your UNSW ID. Link: https://www.library.unsw.edu.au/study/information-resources/newspapers

​B. Practice, practice, practice!

​Identify your goals / objectives and think about how to best position yourself. if you really want to do ER, consider getting placement at a small boutique over the summer, follow stocks, invest yourself, make a mock portfolio, participate in case competitions, go to networking events, read more, do the CFA.

Why are we doing this? What do we need to consider before launching?

Overview of professions and finance in the equity market

Career Paths

  • Investment Banking = Private
  • Equity Market = Public
    • Buy side analysts: Fund management, asset management
    • Sell side analysts: Equity research analysts

Introductory video on how to identify a good stock

How the stock market works

Ethics

A. The Code of Conduct
The CFA has a Code of Conduct that aim to ‘lead the investment profession globally by promoting the highest standards of ethics, education, and professional excellence for the ultimate benefit of society’.
The code can be found through the link below:
https://www.cfainstitute.org/Translations%20of%20Code%20of%20Ethics%20and%20Standards%20of%20Pr/english_code.pdf

B. Integrity of capital markets
Integrity requires that capital markets are transparent, and
security prices accurately reflect the forces of genuine demand and supply

C. Materiality
Information is material if the price of a security would most likely be affected if this information was disclosed publically e.g. earnings and/or revenues, changes in assets or asset quality, legal disputes etc.

D. Duties to clients (see diagram below)
Loyalty, prudence and care- investment actions should be executed for the sole benefit of the client and in a manner that is in the best interest of the client.
Fair dealing- one should deal fairly and objectively with all clients when providing investment analysis, making investment recommendations, taking investment action, or
engaging in other professional activities.
Suitability- make a reasonable inquiry into a client’s investment experience, risk and return objectives, and financial constraints prior to making investment recommendations. Determine suitability of an investment based on the client’s objectives and consistency with their existing portfolio.
Performance presentation- in communicating with clients, one must ensure the information they convey is fair and accurate.
Preservation of confidentiality- one must keep current and former client information confidential at all times unless disclosure is required by law.

Source:https://learningcontent.cfainstitute.org/Kview/CustomCodeBehind/customization/courseware/scorm/cfa_scorm12courseframe.aspx
​E. Conflicts of interest

Identify if a conflict exists, disclose all matters that reasonably could be expected to impair your objectivity.
F. Regulation and trends
There is increasing regulatory pressure on the industry as you can see in the news. A recent example can be outlined below and in the following link: http://www.afr.com/business/banking-and-finance/asic-puts-bankers-analysts-on-notice-with-new-guidelines-20170630-gx1wzo

​Building the toolkit: Where can we find information?

In the industry, we use a range of tools, programs and market sources to help analyse a range of information and datasets in order to come up with a recommendation and viewpoint. A preliminary list is collated below. Some can actually be accessed by your UNSW student log in while others require a subscription payment.
While you may not understand all of these now or know how to use it in depth, it’s always worth having a quick Google and seeing what it’s used for. Please send some time looking through the list:

  • IBISWorld (UNSW subscription) for industry trends
  • Mergent online (UNSW subscription)
  • Merger Market (no UNSW subscription)
  • Factiva (UNSW Subscription)
  • Surveys, third party reports
  • ABS data
  • Consulting reports
  • Whitepapers
  • ACCC papers
  • Credit rating agencies – also product reports
  • Investor relation sections of the website
  • Sector specific industry bodies (Eg. SMI = Media specific)
  • Bloomberg (UNSW Terminal)
  • S&PCapitalIQ
  • IRESS
  • ThomsonReuters
  • Factset

Different information sources also have pros and cons:

Now that we have this information, what do we do with it? How does this relate to company valuations?

The tools outlined above will help you to address the following key items when preparing to value a company:

SWOT Analysis

SWOT examines the strength, weaknesses, opportunities and threats of a project/business venture. The purpose is to analyse a business venture and break it down in a logical matrix. Ultimately, it aims to answer the question: Should we proceed with this project or not?

  • Opportunities and threats are addressed in the external environment
  • Strengths and weaknesses are part of the internal environment.

Macro trends

The PESTELID framework can be used the analyse the macro environment. Trends to affect many industries, but we are concerned with their effect on the growth of the particular industry we are analysing (e.g. Interest rate affects everyone but can specifically hurt the housing market.
​With macro, we must answer two key questions:

  1. What are the major trends affecting the future growth of the industry?
  2. Will this industry grow faster or slower than average industry growth rates?

Political

Economical

Major government trends and issues:

  • Debt / income levels
  • Immigration policy and management
  • Free trade vs. National workforce support (e.g. FTAs)
  • Worker / retiree ratios
  • Pension funding
  • Healthcare funding
  • Climate change adaption
  • Old age / end-of life medical and ethical management

Impacts multiple industries where govt-owned authorities have been major competitors of purchases. Influence can be through legislation, government agencies and administrative regulation. e.g. ACCC

  • Gross National product
  • Personal disposable income growth rates
  • Inflation rates
  • Unemployment levels
  • Interest rates
  • Exchange rates
  • Taxation rates
  • Wage rates

E.G. The demand for international airline travel is highly affected by growth in personal disposable income – ie. As individual’s disposable income increase, their demand for international airline travel increases even faster

Social & Cultural

Technological

Demand for more convenience foods, longer shopping hours / online shopping, smaller houses, increased child care and online dating. E.G. Supermarket product ranges offer a range of cultural food choices

  • Aged care
  • Environmentalism
  • Flexibility of employment conditions
  • Global issue mobilisation
  • Growth / size of population
  • Immigration management (Multi-culturalism)
  • Labour / people mobility
  • Obesity
  • Social networking
  • ​3D printing
  • Artificial intelligence
  • Cloning and bioengineering
  • Fast broadband / mobile communications
  • Fracking
  • Genetic engineering
  • Holographic radiation
  • Laproscopy
  • Nanotechnology
  • Neuroscience
  • Robotic-mediated software
  • Social networking
  • Solar power
  • Voice-activated computing

Environmental

Legal

  • Cost-effective greenhouse gas reductions with technology in building insulation, fuel efficiency in vehicles, lighting, air-conditioning and water-heating system, sugar cane bio fuel, electricity standby and forestation
  • Fossil fuel power
  • Renewables
  • Hybrid technologies over hydrogen fuel cells
  • Regional emission trading schemes
  • Desalination plants for water supply
  • Increased willingness of courts to award damages against malpractices
  • Move away from partnership structures with unlimited personal liability, towards corporate structures with limited liability

International

Demographics

Reductions of trade barriers, changing foreign exchange rates, differential labour rates and increased speed, availability and low cost of international communication of new ideas and good practice

  • Increasing number of customers in emerging economies
  • Shift of activities between and within regions
  • Greater ease in obtaining information and developing knowledge
  • Increasingly flexible international labour markets
  • Increasing constraints in supply or usage of natural resources
  • Increasing communication as a result of technology innovation
  • Population growth + Inflation + Real increase in Performances
  • e.g. 2% population growth + 3% inflation + 1% real increase in volume = 6% growth rate being assumed for the future
  • Australia’s population size (expected to go to 27m)
  • life expectancy of males are 81, females are 86
  • More than 1 in 5 Australians will be aged over 60
  • Percentage of Gen Y in the workforce will increase from 21% to 25%
  • Government expenditure on health will increase from 4% to 8% GDP
Specific examples include:

  1. Political trend – Donald Trump’s assumption as the President of the United States impacts the world as America is a political leader for many countries and affects many sectors in global markets. In the trade industry, his leadership is a threat to import/export relationships e.g. US/Mexico and US/China
  2. Tech – increased mobilisation of all applications (home, video, payments etc). In the banking sector, increasing mobile payment serves an opportunity for many and provides opportunities to draw in greater customer attraction e.g. ANZ’s recent mobile payment has attracted a greater stream of customers which has resulted in greater demand for their products.

Micro trends: Industry trends, risks, pressures (upside / downside)

​The industry environment considers factors within the industry that affect the profitability and competitive position of organisations within it. Porter’s Five Forces of Competition can analyse the industry environment (2nd stage of analysis)

Threat of New Entrants

Bargaining Power of Suppliers

  • Economies of scale
  • Proprietary product differences
  • Brand identity
  • Buyer/customer switching costs
  • Capital requirements
  • Access to distribution
  • Absolute cost advantages
  • Government policy
  • Expected retaliation
  • Differentiation of inputs
  • Switching costs of suppliers and firms in the industry
  • Supplier concentration relative to industry concentration
  • Importance of volume to suppliers
  • Cost relative to total purchases in the industry
  • Information about supplier’s product
  • Supplier profitability
  • Decision makers’ incentives
  • Threat of forward integration

Power of Substitutes

Intensity of Industry Rivalry

  • Relative price / performance of substitutes
  • Switching costs
  • Buyer propensity to substitute
  • Industry growth rate
  • High fixed costs
  • Intermittent overcapacity
  • Product differences
  • Brand identity
  • Informational complexity
  • Concentration and balance
  • Diversity of competitors
  • Corporate stakes & Exit barriers

Bargaining Power of Buyers

​(Essentially a mirror image of the bargaining power of suppliers)

Total addressable market and market sizing

Market sizing can help determine the opportunity, market position and profitability potential. Many interviews also ask this type of question in the following disguise:

  1. How many trucks are there in Sydney?
  2. How large is the land transportation market in Australia?
  3. What is the opportunity of a company if they acquire a company in the Australian transportation market?

There are 2 key manners to tackle these types of questions:
A. Top Down Analysis
Captures the economy, broad sector trends and industry conditions. The starting point is to analyse this by population sor by household (ie. large overall numbers) and then work our way down from there. Ideally, the market analysis needs to determine the total addressable, serviceable and obtainable opportunity.

  1. Understand the total pie of your industry – what is the size?
  2. Determine which slice of the pie you can access – what is the segment and how much can you access?


B. Bottom Up Analysis
Analyses company specifics rather than from a bird’s eye overview. We start by identifying an individual element of a larger population and roll up the numbers until the appropriate scale is reached. E.g. To find out the sizing of bags lost in an airport, we can conduct market research to determine how many times this happens in one day, multiply by the number of days the airport is open, adjust for weekends and holidays, etc etc.
Market Size = (What one customer will pay) x (How many customers you expect to obtain)

Example: How many iPhones are currently being used in China

Step 1: Clarify the question

  • ‘Being used’ likely means ‘in operation’

Step 2: Identify the variables that apply to the problem

  • Population of China: ~1.4 billion people

Step 3: Select an approach to use

  • Make assumptions regarding the population that could afford iPhones:
    • Despite high rates of economic growth in recent years, the majority of the population is low-income and would unlikely be able to afford iPhones
    • Given this, perhaps ~20% of the population could afford an iPhone
    • Total potential market size = 0.2 x 1.4 billion = 280 million iPhones
  • The percentage of the total market that is penetrated:
    • Despite several competitive products produced by other brands, China appears to be heavily brand-oriented and brand loyal to Apple
    • Therefore, it is reasonable to assume ~20% of this segment is currently using an iPhone
    • 0.2 x 280 million = 56 million iPhones currently being used in China

Step 4: follow-up questions

  • E.g. are there are more iPhones in operation in the US or in China?

Source: https://managementconsulted.com/case-interviews/case-interview-frameworks-market-sizing/
http://www.streetofwalls.com/finance-training-courses/consulting-case-study-training/consulting-case-study-101-frameworks/
http://www.streetofwalls.com/finance-training-courses/consulting-case-study-training/consulting-guesstimate-cases/

Market share

A company’s revenue market share can be determined by dividing its total sales or revenues by the industry’s total sales over a specified period. This indicates the size of a company relative to the industry. To size the market position, you can also use a range of internal financial and operational metrics to gauge market share, e.g.

  • Google’s advertising revenues over the total online advertising market expenditure
  • Facebook’s clicks per month over the total clicks per month of all online social media platforms
  • Instagram sign ups over the total social media sign ups per month

Porter’s Value Chain Framework

Porter’s value chain helps identify activities and values used in strategic development. It is useful for the following reasons

  • Determines activities that we need to be efficient and effective in
  • Determines capabilities and gives rise to strength and weaknesses (both tangible and intangible)
  • Identifies activities of a company turning raw materials into customer deliverables to help implement and devise business-level strategies (Identifies cost position)

​Things to start thinking about

  • Company overview- ticker, sector, business description, locations of operations, key financials, key drivers of revenues and expenses
  • Industry overview/trends – federal budget, demographic trends, peers/comparables and competitive positioning, distribution and stability of market share
  • Investment recommendation– share price performance over time relative to a benchmark/index, current stock price, market capitalisation, target price
  • Valuation – multiples, trends over time (historical share price performance) relative to benchmark, gearing, capex (expansionary vs. maintenance), DCF (alternatively P/E or EV/EBITDA or a blended valuation depending on the industry), comparables

    • Absolute valuation: derive an asset’s intrinsic value, and generally take the form of discounted cash flow models
    • Relative valuation: the value of an asset is compared to the values assessed by the market for similar or comparable assets
    • Comparables: although traditional analysis is built on the premise that firms in the same sector are comparable firms, valuation theory would suggest that a comparable firm is one that is similar to the one being analysed in terms of fundamentals.
    • Multiples: standardised estimates of price. 

      • Earnings:

        • Net income: P/E and variants e.g. PEG
        • Operating income and cash flow: EV/EBIT, EV/EBITDA
      • Book value:

        • P/B
        • Enterprise value/invested capital, firm value/book value of capital
      • Selecting a multiple to use? Sector dependant
        • Retail: focused on same store sales (turnover) and profit margins. The revenue multiple is most common in this sector.
        • Financial services: focus on return on equity. Book equity is often
          viewed as a scarce resource, because capital ratios are based upon it. Price-to-book ratios dominate.
        • Technology: growth is usually the dominant theme.
Source: http://mmd.cfainstitute.org/pdf/2015/10887_Damodaran.pdf
  • Catalyst arguments– legislative risks, interest rate environment and gearing, revenue growth prospects

    • Risks to your view/position
      • Potentially negative industry and company developments
      • Risks can be operational or financial in nature, or related to regulatory issues or legal proceedings
    • Broader market behaviour e.g. flight to quality
    • Possible hedging strategies- e.g. short another stock in the same industry if you are recommending going long
    • What does the street say? I.e. other broker reports, the media (AFR etc.)