Survival Kit for an Equity Analyst

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Shin Horie. Survival Kit for an Equity Analyst

Table of Contents

List of Tables

List of Illustrations

Guide

Pages

Survival Kit for an Equity Analyst. The Essentials You Must Know

Preface: Why I Wanted to Write This Book

Introduction: How to Approach Company Analysis

Structure of this Book

List of Acronyms

Part I Lessons from the Past: My Story as an Analyst

From Fish Cakes to Computer Numerical Control (1988–1995)

Not Just a Japanese Tourist – Becoming a China H-share Analyst (1996–1998)

A Truly Global Research Experience – Semiconductor Analyst (1998–2007)

New Lexicon: Clinical Trial, Cap Rate, Embedded Value, Metal Spread (2008–2013)

Importing DM Experience to EM: From Japan to Asia-Pacific (2014–2017)

Connecting the Dots: From Asia to Global (2018–now)

Chapter 1 Understand the ‘Character’ of the Industry

Six Basic Steps for Forecasting Industry Growth. 1: Product and Service Details

2: History of the Industry

3: Definition of TAM and Segments

4: Market Structure

5: Competitor Analysis

6: Global Comparison

TAM Growth Rate

Ten Additional Angles for Testing Forecasts. 1: Replacement Threat from Other Businesses

2: Merging Categories

3: Geopolitical Dynamics

4: Consumer Behaviour Changes

5: Pace of Technology Changes

AUTHOR ANECDOTE

6: Multiple Variables

7: Outsourcing Trends

8: Industry Cyclicality

9: Regulatory Environment

10: Pattern Recognition

Chapter 2 Assess the Earnings Drivers in Different Industries

Hyper Growth – Internet, Fintech, Biotechnology. Internet

Fintech

Biotechnology

Secular Growth – Software, Medical Technology. Software

Medical Technology

Cyclical – Capital Goods, Transport, Energy, Commodities, Chemicals, Autos. Capital Goods

Transport

Energy

Commodities

Chemicals

Autos

Cyclical Growth – Semiconductor, Electronic Components, Technology Hardware, Clean Energy. Semiconductor

Electronic Components

Technology Hardware (Enterprise)

Technology Hardware (Consumer)

Clean Energy

Stable – Consumer Staples, Retail, Consumer Discretionary, Pharmaceutical, Media, Business Services. Consumer Staples

Retail

Consumer Discretionary

Pharmaceutical

Media

Business Services

Interest Rate Sensitive – REITs, Property Developers, Banks, Insurance. REITs

Property Developers

Banks

Insurance

Regulated – Utilities, Telecoms. Utilities

Telecoms

Conglomerates

Chapter 3 Identify the ‘Personality’ of the Company

Product and Service

Origin and History

Management Profile

Ownership Structure

Value Chain

Competitive Moat

Track Record of Strategic Decisions

Corporate Culture by Country

Earnings Guidance Track Record

Controversy Record

Management Quality – A Framework

AUTHOR ANECDOTE

Chapter 4 Put Findings into the Earnings Model

Segmental Revenue Forecast

Income Statement Forecast

Operating Leverage

Product Pricing

Exchange Rate

Changes in Cost Items

Take Rate

Customer Acquisition Cost

Depreciation Cost

Research and Development Cost

Inventory Fluctuation

Companies with Multiple Businesses

Tax Rate

Minority Interest

Dividend and Share Buybacks

Changes in Accounting Standard

Earnings Guidance of the Company

Balance Sheet Forecast

Working Capital

Fixed Assets

Intangible Assets

Debt Management

Cash Balance

Off‐Balance Sheet Items

Cash Flow Forecast

How to Put Cyclicality into Long‐term Earnings Forecasts

Quarterly Forecasts can be Helpful

A Birdseye View is Helpful

Financial and Property Sectors are Unique

AUTHOR ANECDOTE

Chapter 5 Summarize All Thoughts

A Suggested Method for Creating a Practical Scorecard

Chapter 6 Find the Appropriate Valuation Framework

Hyper Growth – Internet, Biotechnology

Secular Growth – Software, Medical Technology

Cyclical – Capital Goods, Transport, Energy, Commodities, Chemicals, Autos

Cyclical Growth – Semiconductor, Technology Hardware, Clean Energy

Stable – Consumer Staples, Retail, Consumer Discretionary, Pharmaceutical, Media, Business Services

Interest Rate Sensitive – Banks, Emerging Market Banks, Insurance, Property, REITs

Banks

Emerging Market Banks

Insurance

Property

REITs

Regulated – Utilities, Telecoms

Conglomerates

Additional Considerations on Valuation. High and Low Multiples

How to Choose Comparable Companies

CROCI

PEG Ratio

Reality Check

Residual Value

Scenario/Sensitivity Analysis

Back Test

M&A Value

Sector‐level Relative View

Chapter 7 Differentiation versus Street

Is the View Actually Different?

1: The Fair Value Conclusion is Different to the Current Share Price

2: The Earnings Forecasts are Different

3: The Equity Story is Different from the One the Market Believes

Where is the Difference?

What is Driving the Difference?

Value of an Undifferentiated Conclusion

Chapter 8 How to Generate Exciting Ideas

1: Burning Questions

2: Products to Solve Problems

3: Forgotten New Technologies

4: ‘Little Stories’

AUTHOR ANECDOTE

5: New Language

6: B2B and Orphan Stocks

7: The Second or Third Derivatives of Structural Changes

8: Local Trends

9: Inputs from the Real World

AUTHOR ANECDOTE

Chapter 9 How to Deal with Disruptors, Emerging Markets, ESG, and Downturns

How to Forecast and Value ‘Disruptors’

Forecasting the Earnings of Disruptors

1: Top‐Down TAM Forecasts

2: Market Share Forecasts

3: Balance Sheet and Cash Flow

4: Margin

How to Look at the Valuation of Disruptors. DCF

Scenarios

Maintenance

How Should Emerging Markets be Looked at?

1: Terminology

2: Things Can Move Much Faster

3: Lack of an Apparent Cohesive Strategy

4: Comparison among Emerging Countries

5: Government Subsidy

How to Think about ESG Issues

1: Definition

2: ESG Data

3: Corporate Social Responsibility

4: Business Opportunities

5: ESG Valuation

AUTHOR ANECDOTE

How to Cope with Economic Downturns

Chapter 10 Using Soft Skills to Power the Analysis. How to Build a Relationship with Companies

1: Trust

2: Mutual Benefit

3: Passion and Preparation

How to Leverage the Team

1: Share Questions

2: Form a Temporary Cross‐Sector Group

3: Casual Chats

4: Debate

5: Joint Presentation

How to Communicate Ideas Effectively

1: Conclusion First

2: Provide Context

3: Know the Audience

4: Use a Few Key Numbers

5: Difference from the Street

6: Listen Carefully

7: Chain of Thought

What Types of Training Should New Analysts Ask for?

1: A Deep Dive Research Project

2: Peer Presentation

3: Critical Thinking Projects

AUTHOR ANECDOTE

Time Management

1: Timetable

2: Management of Managers

3: Research takes Time

4: Quality and Depth First

Part V Recap and Closing Thoughts

About the Author

Acknowledgements

Index

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Shin Horie

Talking about the past and the present is relatively straightforward. Talking about the future is more uncomfortable as no one likes uncertainty or being seen to be wrong in front of other people, which is why there is significant value in a quality attempt at predicting the future of a company. To do this, analysts need to understand many things that require a lot of research and investigation. This book provides equity analysts with a number of helpful hints and tools to help them navigate the complex research process, particularly when they are early in their careers.

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Another memorable research project was about ink jet printer cartridges. When we buy a personal printer, we tend to spend more money on the cartridges as consumables than the hardware and hence for printer manufacturers the majority of their profit comes from selling cartridges. Given these cartridges were heavily protected by patents and a high level of manufacturing process technology, there was no low-cost competition from Taiwan, Korea, and Mainland China then, unlike that faced by other technology products. Sustainability of the competitive edge makes a significant difference to the future profitability for printer makers. Given the high profitability, there were a number of companies entering into the third-party cartridge and refill market to capture the lucrative profit pool. At the same time, the European Union (EU) was investigating the printer cartridge market based on anti-trust concerns. But companies were not particularly vocal about this issue. As such, I needed to do something beyond regular research. I called some of my contacts who supplied materials and parts to the cartridge industry. I then met second- and third-tier printer makers in Taiwan and Korea and the producers of third-party cartridges. I also read patent filings and sought advice from a patent lawyer to learn about cross-licensing agreements. By the end, although there were no clear-cut answers, I concluded that inkjet cartridge technology was resilient enough to stay profitable for the time being. I had learnt my lesson though from the CNC case and tried a more balanced and less rushed approach to the research. Printer makers at that time were saying the cartridge business was resilient because they had a technology advantage but they provided little detail beyond that. So, my extra-mile research effort was very well received, particularly by long-term investors who held large positions in printer companies. Even now ink jet cartridges continue to be profitable and a major source of earnings for printer manufacturers.

In 2008, I passed on my coverage to a colleague and became the Director of Japan Equity Research. On top of all the personnel-related matters, one of the main responsibilities of the Director of Research is quality control of the research product. From day one, for all analysts in Japan, I was required to give advice and approval for rating changes, new thematic reports, and coverage initiations via the Investment Review Committee. I had spent the previous 10 years thinking in depth about semiconductors and hardware technology, and had only limited ideas about other industries. There were many unusual words, such as cap rate, embedded value, phase three clinical trial, and metal spread. I needed to digest and study. Sometimes I spent hours discussing the dynamics of certain industries with analyst teams until midnight. It was a fascinating experience and I felt like a whole new area of my brain not previously used had been turned on.

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