Strategic Capital Group Workshop #1: Investment Fundamentals

AgendaCreating a Company

Types of Financing

Financial Statements

Calculating Value

Exercise and Closing

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.

Currently, we aren’t producing much, and with so many other competitors, we can’t seem to make a dent on the market.

However…

Breaking News: Hippies destroy all T-shirt factories in protest of something!

• Q2FY12 Profits Soar!– Sales up 400%– Profit doubles as customer count skyrockets– Heavy demand need for capital to expand

As the last surviving shirt company, what should USIT Co. do?

Capital Financing: Debt

• USIT T-Shirt Co. can raise debt to fund its growth• Terminology:– Par value: Initial amount paid by investor; returned

at maturity– Interest/Coupon: Amount paid periodically to

investors• Types of Debt:– Bonds (source - public markets)– Loans (source - privately traded or not traded)

Capital Financing: Equity

• USIT T-Shirt Co. can raise equity to fund its growth• Terminology:– Stock: a share of ownership in a company– Initial Public Offering: initial issuance of stock by a

company– Secondary Markets: investors exchanging securities

• Types of Equity:– Common Stock: no guaranteed dividend, vote– Preferred Stock: guaranteed a dividend, no vote

Debt vs Equity

Debt

• Advantages:– Doesn’t seize ownership– Not as influence by market

swings– Easy to raise

• Disadvantages:– Legal obligation to pay– Claim on assets during

bankruptcy

Equity

• Advantages:– No legal obligation to pay– No claims on assets

• Disadvantages:– Giving over ownership

• Shareholder activism• Outside investors (hostile)

– Voting rights

Sanity Check

• We’ve created a company• We’ve talked about debt and equity

• Terminology: Common Stock, Preferred Stock, Bonds, Loans, IPO, Coupon, Par Value, Secondary Markets, Primary Markets

• 50/50 Split– 50% Debt• Senior: more “important” – paid first• Junior: less “important” – paid after senior

– 50% Equity• Meet the investment banker…WE’RE GOING TO

GOLDMAN• All common stock

USIT T-Shirt Co. Raises Debt and Equity

USIT’s Finances

• Total Capital Gain:– 10,000,000 shares at $1.00 share– $5,000,000 in senior-secured bonds– $5,000,000 in junior bonds

• Expanded to 100 countries in less than one year– Indonesia, China, Germany, Chile, etc.– Factories, raw materials, human capital, more garages

• Continued to increase revenues at fast rate

The year rolls to a close…

Public companies are required by the Securities and Exchange Commission (SEC) to produce

financial statements that detail revenues, costs, profits, assets, liabilities, equity, and cash

employed in the business on an annual report or “10-K”.

USIT Co.’s Statements

The Income Statement:-Tells us how much we sold, what it cost us to sell it, and how much profit we made during the period.

Revenue: $100,000,000-Costs: $40,000,000Profit: $60,000,000

USIT Co.’s StatementsThe Balance Sheet:-Tells us what resources are in the business (assets), how much we owe (liabilities) and the equity within the business.

Assets:CashInventoryEquipmentBuilding

Liabilities:Bonds

Equity:Common

Stock

$10,220,000$780,000$2,350,000$6,650,000

$10,000,000

$10,000,000

Sanity Check Part 2

• We’ve learned about accounting• We’ve raised debt and equity for USIT Co.

• Terminology: 10-K, Asset, Liability, Balance Sheet, Income Statement, Revenue, Cost

Valuable Metrics Inside the 10-K

Literally…how much your company earns per each share

Profit Margin =Net Income (Profit)

Revenue (Sales)=

$60 Million

$100 Million= 60%

Earnings per Share =Net Income (Profit)

Shares Outstanding=

$60 Million

10 million= $6 per

share

What percentage of your sales turn are left as profits

A Wild Pokémon Has Appeared! SCG Shirts Co.!

• Another t-shirt company has seen our success and entered the market!Revenue: $120,000,000Costs: $20,000,000Profit: $100,000,000Shares Outstanding: 5,000,000

• Share Price: $2.00• EPS: (100mm) / (5mm) = $20.00

Become The Investor

Which is the cheaper investment?

$1.00 per share

$2.00 per share

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)

=$1.00

$6.00= .17x

SCG P/E =Price (the amount you pay)

Earnings per share (how much the firm makes)

=$2.00

$20.00= .10x

Become The Investor

So now which is the cheaper investment?

.17x .10x

P/E: What Does It Mean?

• Widely varying interpretations– High P/E – investors value the earnings more,

willing to pay more• Could mean optimism

– Low P/E – cheaper earnings• Note: This is all relative– Compare to other companies in industry– “Cheap-er”, “costli-er”

More Ratios

• P/B: Price-to-Book– Book Value: Accounting value of a company’s

assets– Tells us what we are paying for every dollar of

assets the company owns• P/S: Price-to-Sales– Tells us how much we are paying for a dollar of

revenues.

Beta

Beta > 1 = more volatileBeta < 1 = less volatile

Sanity Check Part 3

• We’ve learned about three “Price Multiples”• We’ve covered what Beta is• We’ve compared two companies and decided

which to invest in

• Terminology: Price to Earnings, Price to Sales, Price to Book, Beta, EPS, Margin

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