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Strategic Capital Group Workshop # 3: Split-Second Trading. Agenda. Review of Multiples. How A Market Works. Earnings Reports and Surprises. Company Size and Industry. Flash Crash. Multiples Review. We touched on three multiples in the previous workshops: NAME THEM!

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slide1

Strategic Capital Group

Workshop #3: Split-Second Trading

agenda
Agenda

Review of Multiples

How A Market Works

Earnings Reports and Surprises

Company Size and Industry

Flash Crash

multiples review
Multiples Review
  • We touched on three multiples in the previous workshops: NAME THEM!
  • How are they calculated?

P/E P/B

P/S

buy sell or hold
Buy, sell or hold?

The drink business is typically medium/slow growing, but consistent. When we see stocks undervalued in this kind of industry, it is typically a great time to buy.

P/E = 15.81

P/B= 11.24

P/S = 5.43

Drink Industry

P/E = 22.34

P/B= 15.62

P/S = 7.54

buy sell or hold1
Buy, sell, or hold?

The aerospace industry is slow growing and very stable, when we see stocks trading at higher multiples, they tend to be overvalued.

P/E = 12.18

P/B= 14.70

P/S = 0.76

Aerospace Industry

P/E = 8.75

P/B= 9.24

P/S = 0.65

buy sell or hold2
Buy, sell, or hold?

The technology industry is very fast growing and unpredictable, rendering relative valuation next to useless. We can only assume a high multiple represents expectations of future success.

P/E = 967.21x

P/B = 16.12x

P/S = 17.51x

P/E = 58.43x

P/B = 8.34x

P/S = 9.92x

Tech Industry

slide7
So…
  • Low price multiples designate an undervalued company in industries that grow steadily, but not at huge rates
  • High price multiples represent a market’s expectations of future success in high growth industries like technology.
  • High price multiples in industries with low year-to-yeargrowth are indicative of a company that is overvalued.
sanity check episode i
Sanity Check Episode I
  • We just reviewed the three multiples taught in previous workshops
  • In most cases, a low multiple in an industry that has steady, consistent growth is a buy signal. Where as a high multiple in an industry with rapid growth doesn’t tell us much.
why do stock prices move
Why Do Stock Prices Move?
  • Supply and demand!
  • When there are more buyers of a stock thansellers, the sellers realize they can charge a higher price and get away with it, increasing the stock price
  • The same holds true for when there are more sellers than buyers, driving stock price down
what am i looking at
What am I looking at?

A stock’s price line is actually a series of data points that are plotted and connected. These data points each represent a single transaction of someone buying a stock another person is selling.

check for understanding
Check for understanding:
  • If a stock opened at $50.15 per share and there were no trades for the rest of the day, what is the stock price at the closing of the day?
  • If a stock opened at $50.15 per share and the only 3 trades were $51.42, $49.15, and $50.23, in that order, what is the stock price at the end of the day?
what moves stock prices
What Moves Stock Prices?

3 big factors that affect a stock’s price:

Fundamental

Is the company qualitatively strong?

Technical

Does the company make relatively strong revenues and profits?

Overall Market Sentiment

Does the market think this company will be strong/profitable in the future?

how does news affect a stock s price
How does news affect a stock’s price?
  • Remember back to how stock prices move: Through the number of buyers and sellers of the stock (supply and demand)
    • News changes the number of people who want to buy or sell a stock, thus changing the stock’s price
how does news affect a stock s price1
How does news affect a stock’s price?
  • Negative news reduces a stock’s price because investors think the stock will be negatively affected by the news and more investors begin to sell the stock to either lock-in gains or protect against losses.
  • Positive news increases a stock’s price because investors believe that the company will do better than previously thought and want to capture some of this potential.
check for understanding1
Check for understanding:
  • Target Company:

BREAKING NEWS: Airline industry under fire as FAA increases taxes on flying customers!

Buyers:

500

Buyers:

200

Sellers:

400

Sellers:

700

Stock Price

earnings reports
Earnings Reports
  • Every quarter companies issue a report in which they show how much revenue, costs, profit they made, much like an annual report.
  • Before these quarterly statements, equity analysts predict the earnings per share the company will announce.
  • Investors “price in” these predictions leading into the earnings report.
pricing in
“Pricing In”
  • An assumption of the markets that says at any given time, a company’s stock price is a reflection of all available information and a combination of all future expectations of that company.
  • In English, this means we expect a stock price to stay where it is unless something the market (all other investors) isn’t expecting suddenly occurs.
back to earnings reports
Back to Earnings Reports
  • So let’s now apply the concept of pricing in to a stock leading into an earnings report…

UAL, currently trading at $20.16 per share with $1.17 EPS

Goldman Sach’s equity analysts come out and say they expect UAL to earn $1.50 EPS

Because this is new information to the market, investors scramble to adjust the market price of UAL to reflect the potential to earn $1.50 EPS, coming out to $29.72

back to earnings reports1
Back to Earnings Reports

UAL, currently trading at $20.16 per share with $1.17 EPS

When the earnings report comes out, investors see that UAL earned only $1.22 EPS, a gain of $.05 from last report’s, but $.28 less than expected.

Will the stock price go up or down from $29.72?

DOWN! The market had already priced in that UAL was going to earn $1.50, so the fact that it still beat the $1.17 doesn’t matter to investors.

what if
What if…
  • What would happen if UAL earned $1.51 per share? Would the share price go up or down?
  • What would happen if UAL earned $1.50 per share? Would share price go up or down?
sanity check episode ii attack of the clones
Sanity Check Episode II: Attack of the Clones
  • We discussed what moves a stock price: supply and demand of the actual stock.
  • We looked at how a stock price is calculated: by looking the last completed trade.
  • We talked about how the market “prices in” all available information into a stock’s price
  • We looked at how earnings reports and news can change a stock’s price by forcing the market to price in new information
introduction to market cap
Introduction to Market Cap
  • Market cap is a quick way to “size” a company
  • Calculated by multiplying share price and shares outstanding
  • Generally, anything with a large market cap is considered a safer investment because a large company is less likely to fail than a small one
market cap continued
Market Cap, Continued

Mega-Cap

Large-Cap

Mid-Cap

Small-Cap

Micro-Cap

Nano-Cap

Anything over $200B (General Electric, IBM)

$10B-$200B (McDonalds, Bank of America)

$2B-$10B (United Airlines)

$250M-$2B (First Solar)

$250M or less (Tiny biomedical tech companies)

Remember the T-shirt company in my dad’s garage?

what s a big problem with using market cap as a size metric
What’s a big problem with using market cap as a size metric?
  • Doesn’t take into account debt! What if I have a company that makes billions of dollars every year but is funded entirely by debt?
different industries
Different Industries
  • Financial Services- Medium Growth, depends on consumer confidence
  • Global Industrials- Low Growth, Stable (Boeing, DuPont)
  • Technology/Telecommunications- High Growth, High Margin, Risky, constantly evolving (Apple, AT&T)
  • Health Care- Lots of M&A activity, medium growth, dependent on patent timelines (Pfizer, Eli Lilly)
  • Consumer Goods (Discretionary and Staples)-Stable, low growth, dependent on “blockbuster goods” (Kellogg, P&G)
  • Energy- Medium growth, moves with oil prices, energy demand is used as an indicator of the overall market
  • Materials- Strong indicator of the overall market, demand for materials shows growth
financial services
Financial Services
  • Examples: Goldman Sachs, Bank of America, JP Morgan Chase, Wells Fargo, Citigroup
  • Typically have mid to low growth year to year
  • Dependent on interest rates to make money (higher interest rates mean they make more money)
  • Very dependent on the overall consumer confidence in the economy
global industrials
Global Industrials
  • Produce goods related to manufacturing, aerospace and defense, and construction
  • Examples: Caterpillar, Boeing, 3M
  • Largely driven by supply and demand for building construction, which is also a measure of growth in the economy (more buildings being built shows healthy spending which typically occurs in times of prosperity)
technology and telecommunications
Technology and Telecommunications
  • Covers both sellers to consumers and businesses of technology products and services
  • Depending on the technology, may be cut in economic downturn
  • Historically high growth for technology products and medium to low growth for telecommunications.
  • Examples: AT&T, Samsung, Apple
health care
Health Care
  • Design, manufacture, and sell drugs to hospitals, governments, and pharmacies
  • Reliant upon patent timelines (once a patent expires, the company has to compete with other generic drugs, driving down profit)
  • Very active in Mergers and Acquisitions to get new patents, as well as in lawsuits disputing patents.
  • Examples: Pfizer, Eli Lilly, Abbott Labs
consumer goods
Consumer Goods
  • Split into discretionary (which are higher growth, less stable in economic downturn) and staples (which are more stable with very low growth).
  • These companies follow the overall market fairly closely.
  • Examples: McDonalds, Kellogg, Coca-Cola
energy
Energy
  • Companies that create and/or supply energy
  • Follow oil prices closely, and are good measures of global demand for energy (thus are good indicators of the overall economy)
  • Examples: Noble Energy, Exxon Mobil, Conoco
materials
Materials
  • Companies that discover, develop, and process raw materials. Covers the mining and refining process, as well as chemicals.
  • These companies are good indicators of global growth because demand for raw materials reflects spending on construction.
  • Examples: DuPont, Rio Tinto, BHP Billiton
the flash crash1
The Flash Crash
  • Why is the flash crash important?
  • High frequency trading and trading algorithms can throw the buyer/seller proportion of the markets out of balance, causing massive dips and jumps in stock prices.
  • It’s important to note that the same effect on the market can be achieved by a human. By buying a significant stake in a company (1%-5% or more) all at once, you can skyrocket the company’s price. Make sure you buy in increments if you plan on making a large position!
sanity check episode iii it s over
Sanity Check Episode III: It’s Over
  • You survived 7 of the industry sectors, there’s a few more, but nobody likes to learn this stuff.
  • We talked about what market cap is and how it is used to describe the size of a company
  • We had a 30 second history lesson over the Flash Crash this past May.
announcements
Announcements
  • SimComp is next Thursday in the EDS lab instead of the SCG Workshop- MUCH MORE FUN!
  • If you didn’t like today’s workshop, then next time’s will probably be more investing and less trading/theory/markets.
  • If you did like today’s workshop, then go to SIMCOMP!
  • PAY DUES IF YOU HAVEN’T ALREADY!
  • Good luck to anyone competing in UIA’s Stock Pitch Competition!