The Bull's Pen

Diluted shares outstanding vs. Fully diluted shares Shares outstanding: actual number of shares of common stock that have been issued as of the current date Fully diluted shares: number of shares that would be outstanding if all "in the money" options were exercised Diluted shares = basic shares + dilutive securities Dilutive securities include options, restricted stock, and other securities that can become common stock Types of dilutive securities: Stock options: issued to pay and motivate employees; gives employees the option to purchase common stock at a given price over an extended period of time Check for in the money / out the money Restricted Stock (RSU): another form of stock-based compensation. Employees get shares subject to vesting. Unlike options, there is no exercise price, and employees receive the stock free and clear upon vesting Don't have to check for in the money / out the money Convertible bonds: can be converted into common shares upon a certain strik

3 Main Valuation Methods: DCF Public Comps Precedent Transactions A common interview question will ask you to rank the 3 valuation methods in terms of the highest to lowest valuation yielded. A response to this would be: Generally, precedent transactions would yield the highest valuation because of the control premium and potential synergies that go into an M&A transaction Depending on one's assumptions and the market environment, DCF and Public Comps can be either high or low * Unrelated to the 3 main ones, but LBO is usually the lowest because it is a floor valuation where PE firms can earn their target IRR How to value a private company DCF: FCF projection and Terminal Value calculations are same for public companies But for WACC, private companies don't have an observed equity beta, so you have to use the equity beta from comparable companies in an unlever-relever calculation Public Comps: Apply a discount for the comparable valuation if using publicly traded comps, bec

 Precedent Transaction Analysis: Similar to Public Comps, but instead of comparing the company with what similar companies are currently trading for on the stock market, you are comparing the company with what similar companies have been acquired for in historical M&A transactions Useful in valuing companies that lack good Public Comps or have unpredictable cash flows Same problems as comps Additional problems: Hard to find actual data Every deal has slightly different circumstances surrounding them Why do Precedent Transactions often result in more "random data" than Public Comps? Circumstances surrounding each deal might be very different e.g. one company might have sold itself because it was distressed and about to enter bankruptcy, but another company might have sold itself because the acquirer desperately needed it for strategic reasons and was willing to pay a high price Steps: Determine historical comparable transactions and screen for seller's financial metric

 Relative Valuation Introduction: Instead of projecting a company's cash flows, relative valuation is to value a company based on similar companies' valuation multiples e.g. P/E, EV/EBITDA, EV/EBIT, etc This is helpful because if you know a very similar competitor to your company is trading at a 10x P/E multiple, it's likely your company should also trade at a 10x P/E multiple - or close to it. Public Comps is based on the data of publicly traded companie Public Comps: A market-based valuation method that uses the current market value of other comparable companies to determine the implied value of the target company. Steps to doing a Public Comps: Select the appropriate set of comparable companies Size, geography, industry Screen for financial metrics you want to use EV/EBITDA or PE or EV/EBIT or other metrics Note: different multiples are better for different industries Calculate the multiples for all the companies based on their publicly accessible information Apply media

How do the 3 financial statements link with each other? First, net income from the bottom of the income statement flows to the top of the cash flow statement into cash flows from operations. Together with CFI and CFF, the cash flows into the assets section of the balance sheet. Finally, net income from the income statement flows into retained earnings under the equity section of the balance sheet. How does a $10 increase in Depreciation affect the 3 financial statements? Assume a 40% tax rate Assuming a 40% tax rate, the net income at the bottom of the income statement would be -6. We add back 10 in the cash flow statement under CFO. The net change in cash at the bottom of CFS is 4. +4 goes into the assets section of the balance sheet, but PP&E goes down by 10 due to depreciation. -6 net income flows into retained earnings under the equity section of the balance sheet. The balance sheet is balanced. What changes impact the income statement? The income statement is based on accrual

Careers in Banking Investment Banking Division Coverage Team: focuses on one specific sector of clients, and all deals are from that same sector e.g. TMT, Healthcare, Industrials, Real Estate, FSG, FIG Product Team: different deal-related services  e.g. M&A, ECM, DCM, Leveraged Finance, Restructuring Sales and Trading Sales: selling different investment products (e.g. Equity, Bond, Derivatives) to the buyside clients Trading: trading these investment products and cooperating with sales team to give clients product price and make money on the spread Asset and Wealth Management Client-focused, with the clients being large financial institutions or wealthy families/individuals. Daily work include managing relationships and providing different investment products to clients' portfolio Investment Banking Investment Banking is a type of banking that helps clients (companies, institutions, governments, etc.) with raising capital via initial public offerings (IPOs) and executing transa

Review: If you haven't yet, go back and read the article on WACC before starting this one Remember these formulas from the previous article: WACC = (% Equity * Cost of Equity) + (% Preferred Stock * Cost of Preferred Stock) + (% Debt * Cost of Debt * (1 - Tax Rate)) Cost of Equity = Risk-free Rate + Levered Beta * Market Risk Premium EV = EqV - Cash + Debt + Non-Controlling Interests + Preferred Stock EqV = EV + Cash - Debt - Non-Controlling Interests - Preferred Stock  Introduction to Valuation There are 2 main ways to value a company: Relative Valuation: using market historical data of similar companies or transactions to value a company Public Comps (Comparable Companies Analysis) Comparing the valuation multiples (such as PE ratio or EV/R ratio) of similar publicly traded companies to determine a valuation range Precedent Transaction Analysis Similar to Comps, but used more commonly in M&A scenarios. Also known as "M&A Comps" Analyzing recent transactions of

WACC/Discount Rate: For investors : discount rate is the expected rate of return of investing in a company. It represents the opportunity cost of what they could earn by investing in other similar companies in the industry Higher discount rate = higher risk = higher returns Smaller companies tend to have higher discount rate than larger ones For companies: discount rate is the cost of capital To calculate discount rate, we separate capital structure into components of equity, debt, and preferred stock, and calculate the cost of each one WACC: weighted average cost of capital WACC is used as the discount rate in a DCF to calculate the present value of a company's cash flows and the terminal value It reflects the overall cost of a company's raising new capital, which is also a representation of the riskiness of investing in the company WACC = (equity * cost of equity) + (preferred stock * cost of preferred stock) + (debt * cost of debt * (1-tax)) Essentially a calculation of a f

Enterprise Value (EV) : value of a company's core business operations to all investors Equity Value (EqV) : value of everything a company has to its equity investors (common shareholders) Equity Value & Enterprise Value Conversion: EV = EqV - Cash + Debt + Non-Controlling Interests + Preferred Stock EqV = EV + Cash - Debt - Non-Controlling Interests - Preferred Stock Why do we subtract cash to get to EV from EqV: EV, in broad terms, is the present value of a company's future cash flows. The excess cash (not all cash is excess cash) on the books is a non operating asset (non core business operation). It does not aid the generation of future cash flows and therefore does not contribute to value. That's why it is subtracted Also, the equity value of a company already includes the cash on the company's balance sheet. So we need to subtract it or else we'd be double-counting From an intuitive standpoint: when we acquire a company, we'd get the excess cash as pa

 Present Value: Time value of money: money today is worth more than money tomorrow. Future money must be discounted to its value today, or the "present value."  Present Value: the current value of a future sum of money given a specified rate of return Present Value = Future Value / (1+r)^n r = discount rate (expected rate of return on investment, think of it like opportunity cost) n = time period Discount Rate: Refers to the interest rate used to determine the present value Higher risk = higher returns = higher discount rate Higher discount rate = lower present value Perpetuity: Stream of cash flows that continue forever PV = CF / r CF = cash flow r = discount rate Growing Perpetuity: Stream of cash flow that is expected to be received every year forever but also grow at the same growth rate forever PV = C / r - g C = cash flow in year 1 r = discount rate g = growth rate Net Present Value (NPV): Difference between the present value of cash inflows and the present value of cas

Accounting Ratios: Profitability Ratios: Gross profit margin = Gross profit / Revenue Operating margin = Operating profit / Revenue Net profit margin = Net income / Revenue Return on assets = Net income / Average assets Return on equity = Net income / Total equity Leverage and Solvency Ratios: Debt to EBITDA = Debt/EBITDA How much debt a company has compared to how much it makes Helps us understand if the company has taken on too much debt compared to what it can afford to pay back. Higher ratio = more debt, so could indicate that the company is in a dangerous situation. But if the ratio is too low, it could indicate that the company is inefficient Interest coverage ratio = EBIT / Interest expense Way to see if company can easily pay the interest on loans A high interest coverage ratio means you can easily pay the interest because you're earning a lot more money than what you owe in interest

 Introduction: There are 3 financial statements to know:     Income Statement : details the taxes , revenues , and expenses a company incurs in a period of time     Cash Flow Statement : determines how a company manages its cash position and tracks changes over a period of time, divided into CFO (cash flows from operations), CFI (cash flows from investing), and CFF (cash flows from financing)     Balance Sheet : shows a company's assets and how it acquired them using equity and liabilities at a specific point in time