strategic capital group workshop #1: investment fundamentals
TRANSCRIPT
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Strategic Capital Group Workshop #1: Investment Fundamentals
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AgendaIntroduction to USIT & SCG
Creating a Company
Financial Statements
Raising Capital
Exercise and Closing
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Meet the USIT Shirt CompanyCurrently run out of Parker’s dad’s garage, we are providers low cost, awful quality t-shirts to any suckers who will buy them.
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The Business + Key TermsWe sell t-shirts for $20 each, and on sell 100 per year
The $2,000 of sales we make each year is referred to as revenue
We pay Parker’s little brother $2 per shirt to assemble and $3 per shirt for the input materials.
Price x Volume = Revenue
This $5 per shirt of costs are referred to as cost of goods sold, or the direct costs of the inputs and labor that goes into the product
Cost per unit x Volume = Cost of Goods Sold
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The Business + Key Terms
Benedikt, the CEO, who does not actually make the products, gets paid a fixed $500 salary per year.
The $500 paid to him is referred to as an operating expense
Operating expenses are not the same as cost of goods sold because they reflect costs uninvolved in production
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Now how to we represent the state of the business?
The Income Statement
Revenue $2,000
-COGS 500
Gross Profit$1,500
-Operating Expenses 500Net Income
$1,000
• Tells us how much the business sold and what it cost to sell the products, all the way down to the leftover profit.
• Typically shows the state of the business for a year or a quarter of a year
• Important to know how profitable the business is
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The Income StatementKey terms:
Gross Profit Margin =
Net Margin =
Gross Profit
Revenue
Net Income
Revenue
$1,500
$2,000
$1,000
$2,000
= 75%
= 50%
After paying off all expenses and costs, 50% of every dollar of sales will be left over as profit.
As this percentage increases, the amount of costs per dollar of sales are declining and the business is becoming more cost efficient
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The Business + Key TermsParker contributed $500 of cash when the business first started
Benedikt loaned the business $500 dollars
$200 was used to buy a t-shirt making machine.
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The Balance Sheet
Assets Liabilities Equity
What you own What you owe What’s contributed and left over
= +
Cash $500Machinery $200
Loan from Ben $500 Contributed Capital $500$1,000$800
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Sanity Check #1
• We’ve had an introduction to two financial statements (forms that describe a business’s condition)– Balance Sheet – tells us about the resources of the
business and how they were funded– Income Statement – tells us how much we sold
and how much we spent during a period
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ExpandingA sudden fad for overpaying for cheap shirts has developed, meaning demand for USIT Co.’s shirts has skyrocketed.
Making t-shirts out of Parker’s dad’s garage is no longer enough, and we need to expand.
In order to expand, we need to buy more buildings, more machines, and more inventory.
To get more assets, we need more capital!
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Options for Raising Capital – “Financing”
Debt (liabilities) Equity
Types of debt:• Loans – offers of money now
in order for a promise of a return of capital and interest later on
• Bonds – a loan that can trade ownership on public exchanges
Types of Equity:• Common stock – the traditional
stock, or shares of a company that are traded on stock exchanges. These represent fractional ownership of a company and claims on voting rights and profits
• Preferred Stock – stock that has no voting right, but has guaranteed payments from a pool of profits
Key Terms:Debt Equity
• Face Value – the amount of money returned to the lender at the end of the loan/bond
• Maturity – the amount of time before the loan is due back
• Interest/Coupon – the required payments to investors
• Initial Public Offering – the first time a company puts its stock for sale to any investor through a stock exchange
• Secondary Market – the market where investors can publicly exchange stock
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So which do we choose?Debt Equity
Advantages• Your creditors (loaners) have
no control over the company• Easy to raise• Good tax implications
Advantages• You have no obligation to pay
anyone. Investors are not guaranteed distributions
Disadvantages• You are legally required to pay
interest and principal or risk bankruptcy
Disadvantages• You are essentially selling
control of your company. If you sell more than 51%, your decisions can be vetoed
• Potential for hostile investors
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…and how do we do it?Step 1: Find an investment banker
Step 2: Have your investment banker overwork his junior bankers to figure out what your company is worth, then find people to invest in your newly issued securities
Step 3: Figure out how much money you need to raise, then sell that proportion of your company (if equity)
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Sanity Check #2
• We’ve talked about the two ways to raise capital:– Debt – loans with obligatory interest payments– Equity – stock with no obligation to pay, but gives
away voting rights
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USIT Co.’s Capital DecisionDebt Equity
• $10M of “senior” bonds at a 5% interest rate
• $10M of “junior” bonds at a 10% interest rate
• $50M of proceeds from issuing 1M shares of stock related to a 25% stake in the company
How much money in total did we receive?
How much is the total equity of the company worth?
What was the stock price we issued at?
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Stock price is arbitrary!It’s important to note that the company chooses the stock price it wants to issue at.
We could have issued:
10 million shares @ $5 per share
100 million shares @ $.50 per share
1 share @ $50 million per share
Either way, we still receive $50 million dollars in proceeds
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ImplicationsAfter raising publicly-traded stock, you are considered a public
company. Every quarter and at year end, you file an annual report with various financial statements and notes called a 10-K
or 10-Q
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A quick update on what our new balance sheet looks like, post-financing
Assets:Cash
$70,000,800Machines $ 200
Liabilities:Loans $ 500Bonds Payable $20,000,000
Equity:Common Stock $50,000,000Contributed Capital$ 500
$70,001,000
$70,001,000
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Let’s fast forward a year…
The Income Statement
Revenue $100,000,000-COGS (40,000,000)Gross Profit $60,000,000-Operating Expenses (50,000,000)Net Income $10,000,000
Earnings Per Share $10.00 Net Income (earnings)
Shares of stock outstandingEPS =
Literally…how much your company earns per each share
Stock price at issuance: $50 per share
Number of shares: 1 million
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ValuationFinance is the process of raising capital for a business, but in order to know the appropriate amount of capital to raise and
how much it will cost, we need to value a company
Investors and bankers have several tools to value a company, but first…
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ValuationYour exotic friend asks you to go buy this fruit you’ve never seen for him, but to not spend too much for him.
The fruit is only sold by one vendor and costs $5 per pound, but you have no idea if that’s a good price. What do you do?
You compare it to other things that are like it, namely, other fruit!
You can refine your search further by comparing to other fruit that look and taste like it.
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The same concept can apply to companies:
Price = $50.00 per
share
Price = $5.00 per
shareWhich is the cheaper investment?
T-shirt Co
T-shirt Co
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What about if we look at EPS?
EPS = $10.00 per
share
EPS = $3.00 per
share
USIT seems to pay out more per share…
T-shirt Co
T-shirt Co
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P/E- The Price to Earnings RatioShare price is not enough!P/E: how much does one dollar of
this company’s earnings cost?
USIT P/E =Price (the amount you pay)
Earnings per share (how much the firm makes)
=$50.00
$10.00= 5x
SCG P/E =Price (the amount you pay)
Earnings per share (how much the firm makes)
=$5.00
$2.00= 2.5x
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Become The Investor
So now which is the cheaper investment?
5x 2.5x
Remember: P/E ratios are a measurement of how much you pay per dollar of earnings
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The answer is… there isn’t one.
• Widely varying interpretations of P/E– High P/E – investors value the earnings more,
willing to pay more• Could mean optimism
– Low P/E – cheaper earnings, better deal• Note: This is all relative– We are comparing to similar companies– “Cheap-er”, “costli-er”
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Valuation
• Relative valuation is just one of the ways we value a company and has its advantages and disadvantages.
• Later during the year we will discuss different ways to value a company and will flesh out further how to use these tools.
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Sanity Check #3
• We’ve learned about the P/E multiple• We’ve compared two companies and decided
which to invest in
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Exercise
• Which of the following companies would you buy? Why?
Company Price Shares Assets Revenue Profit Margin P/E P/B P/S
USIT $4.00 10,000,000 $11,000,000 $100,000,000 $33,300,000 33.3% 1.20 3.64 0.40
SCG $7.57 5,000,000 $12,000,000 $125,000,000 $48,000,000 38.4% 0.79 3.15 0.30
UCF $82.53 1,000,000 $19,800,000 $228,000,000 $49,500,000 21.7% 1.67 4.17 0.36
Nike $67.73 2,000,000 $8,000,000 $48,000,000 $35,700,000 74.4% 3.79 16.93 2.82
Average $40.46 4500000 $12,700,000 $125,250,000 $41,625,000 41.9% 1.86 6.97 0.97