Welcome to Finance and Accounting Abhijan Khosla (Director of Mentorship)

Welcome to Finance and Accounting

Abhijan Khosla (Director of Mentorship)

GTSF Investments Committee2

Debt vs. Equity Debt is a loan

If things go south you get first rights to what’s left in the company (usually hard assets)

Equity is ownership There is only a fixed amount of equity in a

company You can make more but the existing owners

shares are worth less As an owner you have rights to the company’s

profits (EPS/Dividends) When things go south you go last


Quiz Time!Who is the father of value investing?

1. Alexander Graham Bell 2. Benjamin Graham 3. Warren Buffett4. Ben Bernanke


Quiz Time!You shorted AAPL at $750 and covered at $250

(assuming $10 in fees) how much do you make on this trade?

1. 2002. 4903. -2004. -190


Quiz Time!Which is not true of an OTC Market?

1. The prices are not listed in any central location

2. Buyers assume all the risk 3. Market makers help to determine prices4. Fixed income is an example of an OTC

security


Who Am I?


The 1 thing you need to know

A dollar today is worth MORE than a dollar tomorrow

Today > Tomorrow


Time Value of Money Interest has an impact on the value of an

investment If compound interest is used then the growth

of an investment in different time periods reflects all previous interest earned

If I earned 10% a day on $100 how much would I have tomorrow? In 4 days? In 10 days?


Time Value of Money Use a timeline to visualize cash flows Future Value - Value at a time in the future Present Value - Value in “todays dollars” Which one should be greater? Formula;

FV = PV (1 + I/Y)^N FV = future value

PV = present value I/Y = interest rate per period

N = number of periods


A few practice problems Bill earns a 4% annual return on his HLF

short, if he invested $1,000 exactly 3 years ago how much does he have today?

Ben needs $50,000 by 2020, if he started investing in 2014 and earned a 5% annual return how much does he need to invest?

Geoff began investing in 2010. He invested $100 and earned a 2.5% quarterly return. How much does he have today? How much will he have in 5 years?


But.....Why? As in investor you must be compensated for

giving up your money Compensation depends on risk What are some main risks?

Counterparty (Default) Risk Reinvestment Risk Maturity or Duration Risk


The 3 Financial Statements What are the 3 Financial Statements?

Income Statement

Statement Of Cash Flows

Balance Sheet


● Called a snapshot in time● Reflects the company’s assets, liabilities and

shareholder equity at the time (quarterly or annually)

● Listed in order of Liquidity

Assets = Liabilities + Shareholder Equity

Balance Sheet


Income Statement● Major Line items of an Income Statement;

Revenues - Cost of Goods Sold

Gross Margin- Operating ExpensesOperating Income

- Other Expenses-Income TaxesNet Income


Income Statement


Statement Of Cash Flows(CF) 3 Components of the Statement of CF

Cash from Operations

Cash from Investing

Cash from Financing

Beginning Cash + CF from Ops+ CF from Investing + CF from Financing = End Cash


Statement Of Cash Flows(CF) Cash from Operations

Cash generated from the normal operations of the company

Cash from Investing Change in cash from activities outside normal

scope of business May include the purchase of property, plant and

equipment, and other investments not on the income statement

Cash from Financing Cash from the issuance or repurchase/repayment

of equity and debt


The 3 Musketeers

● The 3 statements work together;

Net income (Income

Statement)

Cash flow from Operations

(Statement of CF)

Cash from previous Balance

Sheet (Balance Sheet)

Beginning Cash Balance

(Statement of CF)

Ending Cash Balance

(Statement of CF)

Cash on Balance Sheet

(Balance Sheet)


Company Reporting Any publicly traded US company is required

to report comprehensive financials Quarterly reports - 10Q Annual Reports - 10K Foreign companies with stock trading in the

US must also file annual and quarterly financial reports

sec.gov Footnotes –can often house interesting

information about the company that must be disclosed but is not part of the 3 financial statements


Valuation What is valuation? Who uses valuation? What are some of the most common metrics

used when valuing a company? What are some of the different ways to value

a company?


Valuation Basics Valuation is the procedure of calculating the

worth of an asset, security, company, etc... Valuation is one of the primary tasks done by

investment banks Being good at providing valuations for

companies is an invaluable skill set used in all facets of finance

There are 4 main ways to value companies Comparable Companies Precedent Transaction

Discounted Cash Flow Modeling Leverage Buyout Modeling


Commonly Used Metrics One way to value a company is to compare it

to its peers (Comparable Multiples Method) There are a multitude of multiples used The most common are

Enterprise Value (EV) /EBITDA Price/ Book Value Price/Earnings PEG EV/Sales Price/Sales


Enterprise Value (EV) EV- Enterprise Value

Value of the entire firm including both debt and equity

EV = Market Value of Equity + Debt + Preferred Stock + Minority Interest - Cash

Why take out cash? Cash is already counted in market value in equity

(in theory) You can use cash to pay down debt or pay a

dividend - you would not buy a company for its cash


EBITDA EBITDA - earnings before interest, taxes,

depreciation and amortization Good way to evaluate a company’s

profitability EBITDA = Revenues - Expenses (excluding

taxes, interest, depreciation and amortization)

Represents the earnings that can effectively service debt, rose to prominence during the leverage buyout boom of the 80’s


Income Statement


Free Cash Flow (FCF) Simply the amount of free cash a company

has Formula: EBIT (1-tax rate)+Depreciation &

Amortization - Change in Net Working Capital - Capital Expenditures

NWC = current assets - current liabilities Why do we use 1-tax rate? Why subtract Change in NWC and Capital

Expenditures?


EV/EBITDA Essentially “at what multiple of earnings is

the entire company valued at” EV/EBITDA is the most common metric used

when doing comparable multiple analysis Varies greatly with industry If the industry average EV/EBITDA multiple is

6X and your company has an EBITDA of $100MM what is your company’s EV?


Price/Book The current share price / book value of the firm Book value = total assets - intangible assets -

liabilities Book value is the theoretical value of assets that

would be recovered in the event of a total firm liquidation

Assume ; Total assets; 10MM Intangible assets; 1MM Liabilities; 6MM Market Value; 21 MM Price/Book?


Price/Earnings (P/E) The PE ratio of a firm is the multiple at which

the stock price is trading as compared to earnings per share (EPS)

P/E - Current stock price / EPS Stock Price - 502.20 EPS - 40.44 P/E - ? What do you do if you have negative EPS?


PEG The PEG ratio of a firm is the Price/Earnings

to Growth ratio P/E ratio divided by the growth of the

earnings over a specified period of time Can be in the past or the future (trailing vs

forward) PEG takes into account the growth of

earnings and helps to give a more complete picture of relative price

If our firm’s P/E was 40 and our annual EPS growth rate was 20% what is our PEG?

For what kind of firms would PEG be a good metric?


Price and EV/Sales Price/Sales

Current Market Cap / Sales EV/Sales

Enterprise Value/Sales If AAPL generated $32MM in sales has a

market cap of $640MM , debt of $17MM and cash on hand of $20MM what are the price/sales and EV/sales ratios?

Name 2 companies for which Price/Sales is a good metric and 2 for which it is bad


DCF and LBO DCF - discounted cash flow model

A common modeling method which uses free cash flow (similar to EBITDA) to drive the valuation of the firm

We project out FCF, decided on terminal growth rates and discount the cash flows back to present day

LBO - leverage buyout model Used primarily by PE firms when valuing

companies they may be interested in acquiring Centered around the use of enormous amounts of

debt which will be paid off to increase the PE firms relative ownership stake


Other Ratios Valuation ratios are used to determine how a

stock is valued in the marketplace All the metrics described depend on the

current price of the stock or the current market capitalization of the company

These ratios are often swayed by market dynamics which are not always accurate

Efficiency ratios help us to simply look at the effectiveness of the company without the market’s interference


Efficiency Ratios Allow investors to see how effectively a firm

is using its resources The most common are;

Operating Margin Profit Margin Return on Equity Return on Assets Return on Invested Capital


Operating and Profit Margin Allow investors to see what percentage of

each dollar made translates to the company’s bottom line

Operating Margin EBIT/Sales gives an idea of how well management has been

at generating income from the operation of the business

EBIT includes all revenues, not just sales Profit Margin

% of sales that flows directly to profit Net income/Sales


Income Statement


Return on Equity and Assets Return on equity represents the amount of

profit generated on each dollar of equity funding in the company Net Income/ Shareholders Equity

Return on Capital represents the amount of profit generated on each dollar of assets held by the company Net Income/Total Assets Helps to measure how good management is at

using assets on hand


Return on Invested Capital Return on invested capital is a measure of

how well capital is being used to generate profits, essentially with all the funding being given to the company how much are they using to make money?

Net income - Dividends / Total Capital Use the balance sheet and income statements

on the next slides to calculate Return on Equity, Assets and Invested Capital


Income Statement


Ratios in Perspective Ratios help to clarify investing theses It is important to use ratios and number to

backup your thoughts about a company There is no “magic ratio” Learning which ratios work the best takes

time and experience The one thing you NEVER use to decide on an

investmentPRICE

Welcome to Finance and Accounting Abhijan Khosla (Director of Mentorship)

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