Stock Analysis in practice – creating

a structured framework for thinking

Charles Payne
Investment Consultant
Partners on Demand Limited

NOVEMBER 2017
Agenda 2

 Investing – art and / or science?

 Some real life illustrations

 The Unsolvable Puzzle?

 A starting checklist to structure your early analysis work

 Some ideas for interesting reading

 A stock to apply learning – second session on 8th October

 Questions / interview ‘clinic’

Investing – Science or Art?
Is it about Economics or Psychology?
3

Point of
Maximum
Financial RISK
Wow, I feel GREAT
about this
investment! Euphoria Temporary setback, I’m
Thrill Anxiety a long term investor…
Denial
Excitement Fear
2006 Optimism
Optimism 2008/09
2016 ?
Desperation Panic
2002/03 Relief

Capitulation Hope

Despondency Depression
Maybe the markets
just aren’t for me
Point of Maximum
Financial
OPPORTUNITY

720/0309
Science and Art 4
Type A numbers and Type B numbers

 Type A numbers are SCIENTIFIC - FACT based - “easy” to deal with

Share Price – Euro 17.5

 Type B numbers are ARTISTIC - SENTIMENT based – ‘hard’ to deal with

You CAN’T exclusively use Type A numbers to give you Type B numbers!
Figuring out the big picture 5
From the most incomplete fragments

 However hard you work, you

never get 100% conviction
understanding
 There is ALWAYS a ‘Leap of
Faith’
 As a result you’ll be wrong 45%
of the time – minimum!
 Can you make a decision
based on incomplete facts?
 Can you cope with failure?
The world of Fabulous Facts 6
The metro network of the worlds capitals
Underground train networks in France, Japan, UK, China & India

Paris Tokyo London

Beijing 2008 Beijing 2050 Delhi 2011

The world of Fabulous Facts 7
How many airports does China need?
Airport Density in 2010 – China, India & US

China India US
 Creating your own map of the World 8
The importance of Value Chains

Iron ore Shipped to Steel sold Rubber used to Car

Iron ore Car
shipped mill to make to auto parts manufacture distributed &
mined assembled
by dry bulk steel producer tyres sold globally

HYUNDAI
BHP COSCO US STEEL MICHELIN DAIMLER INCHCAPE
MOBIS
 Where in the chain should you be? 9
Seeking out Asymmetry
Invest in beneficiaries of
Inflection Points lower iron ore prices (autos)

Macro view
Iron Ore price

Stock Picking

Macro view

Time
Invest in beneficiaries of
higher iron ore prices (miners)
The macro impacts on individual stocks 10
Example - oil price and energy stocks
Relative portfolio energy weighting versus the oil price

Energy relative weighting (LHS) Oil price (RHS)

12.0 120

10.0

London Brent Crude Oil Price (US$/Barrel)

110
8.0
Fund - Relative % Weighting

6.0
100
4.0

2.0
90
0.0

-2.0
80

-4.0

-6.0 70
Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11
 Why do company research at all? 11
A real world example
Company Perspective Stock Implications

Expect higher exploration

Occidental / Anardako
BHP BILLITON in Gulf of Mexico
1 : 1-MEETING
Finding it difficult Michelin /
to source tyres Bridgestone

Don’t like the dynamics of

Norilsk Nickel
nickel

Increased demand from

China Property / Steel
China

Favour the long term

Antofagasta / FCX
dynamics for copper

South Africa is a difficult Anglo Platinum / Impala

environment to operate Platinum
‘Only connect’- meet a UK miner…
… buy a Japanese tyre manufacturer 12

Specialist tyre
pricing power

Consumer Decrease in
down BRIDGESTONE new vehicle
branding CORP. purchases

80% sales in
replacement
market
The laziness of the index 13
Thinking beyond the group think
Nuance Communications Inc.

 Classified by the index

as a Technology stock
 1/3rd of revenues come
from sales to the
Health sector
 Tech sector trading at a
2 percentage point P/E
discount to Healthcare
 Rerating opportunity
The Jerry Maguire theory of analysis 14
Show me the money!
Income Expenditure
Kimberley Clark Corp

 Cash generative
Consumer Staples stock
 High cash visibility
 Strong capital discipline
 Excellent shareholder
visibility
 High ‘margin of safety’
for dividend cover

Operations Borrowing
Interest on Debt CAPEX Dividends Buyback M&A
The Unsolvable Puzzle? 15
Is investing Physics, or Biology?
 Physics = absolute laws that once
discovered, don’t change

 Biology = observed laws that are constantly

evolving as a result of accidental mutations

 Too many investors (both quant and

fundamental) think like Physicists – seek for
an absolute truth that once discovered will
work forever

 The world changes – and your investment

thinking must evolve too!

 Be flexible, self-challenging, observant and

most of all BE AWAKE!
The Unsolvable Puzzle? 16
What we can learn from Ben Graham
 Ben Graham ‘The Intelligent Investor’
– first published in 1949.

 Republished three times before he

died in 1976 – in 1954, 1965 and
1972

 In each of these updates he

completely revised his assumptions
and formulae

“ We will never permanently solve the investment puzzle, because

solutions have shelf lives, and expiration dates that are usually only
obvious in hindsight.”

Morgan Housel “The Unsolvable Puzzle” www.collaborativefund.com

An analysis checklist – Part 1 17
Not exhaustive – but an essential start
 Yield – and its sustainability

 P/E ratio – vs. total market and peer group

 P/B ratio – vs. total market and peer group

 PEG ratio – greater or less than 1?

 Cash transparency & Capital discipline

 Value chain – when to buy and when to sell

 M&A – target or acquirer?

 Pension scheme deficit

 Regulatory and geopolitical risk / opportunity

An analysis checklist – Part 2 18
Not exhaustive – but an essential start

 Potential for re-rating & SOTP revisions

 360 degree analysis – suppliers, clients and competitors
 Height of ‘barriers to entry’ / uniqueness of franchise
 Optionality – new product launches, sale of non core assets
 Quality of management / key man risk
 Recent IPO – especially from Private Equity
 New CEO – ‘backpacking’
 SRI / Ethical / reputational risks
 FX exposure and dynamics

 And MOST IMPORTANTLY – what do I think I know that no-one else does?
Some books to think about 19
One obvious, two less so

 The obvious one:

 ‘ One Up on Wall Street ’ – Peter Lynch

 The more challenging options:

 ‘ Tools for Thought ’ – C.H. Waddington

 ‘ The Psychopath Test ’ – Jon Ronson
Stock for analysis exercise 20
Schroders plc (SDR:LN)
 A two page precis of your investment thesis as to whether
the stock is a Buy or a Sell (no ‘Holds’ allowed!) ready for
the next session on October 7th
 Demonstrate an understanding of what the street knows,
plus evidence of unique insight that leads to your
conclusion
 You may work individually, or in groups
 You should expand your reading as widely as possible
outside the given starter list
 To make sure that the next session is focussed and
worthwhile, only those submitting a two-sider will be
eligible to attend. Submissions to ‘Stock Pitch submission
invite’ Job id 58001 on Career Central by 4th October
Schroders PLC 21
Analysis source materials – for starters
Annual Reports
http://www.schroders.com/en/investor-relations/results-and-reports/results-
reports-and-presentations/

Charts and newsfeeds

https://www.bloomberg.com/quote/SDR:LN
http://www.google.co.uk/finance?q=LON:SDR

Background sector trends and reading

https://seekingalpha.com/article/4060298-consolidation-expected-within-asset-
management-industry
https://www.bloomberg.com/quicktake/active-vs-passive-investing
https://www.ft.com/content/ba243304-e224-11e6-9645-c9357a75844a
https://www.forbes.com/sites/jonhartley/2014/10/06/how-google-is-poised-to-
become-a-dominant-investment-manager/#4dae2ab27e87
https://www.ft.com/content/0bb9f8ce-d330-11e6-b06b-680c49b4b4c0
https://seekingalpha.com/article/4064866-different-take-active-vs-passive-
management-debate
http://citywire.co.uk/new-model-adviser/news/schroders-buys-major-stake-in-rwc-
partners/a408884
Interview ‘Clinic’ 22

 Open floor discussion on what buy side houses are

looking for from a candidate
 Why would you want to work on the buy side in the first
place?
 How selection days are typically structured
 Some guidance on what to say – and some things not to
say
 Any questions I may be able to help with, or thoughts and
observations