‫Modeling and valuation.
‫Congratulations, you're now on the green stage,
‫or the fifth stage.
‫You're in year seven to eight.
‫You're gonna go public very soon,
‫and we're gonna deal with Goldman Sachs
‫and maybe Morgan Stanley.
‫It's gonna be a lot of fun.
‫But before we do that,
‫you're gonna play the role of the financial analyst.
‫So how do Wall Street analysts make financial models
‫and how do they value companies?
‫So you're not gonna be a student anymore today.
‫That's right, you're a financial analyst,
‫you work on Wall Street.
‫So you're gonna learn exactly how Wall Street analysts work,
‫you're gonna learn what their secrets are,
‫you're gonna learn how they do due diligence,
‫how they model companies.
‫And a good analyst doesn't need others
‫to form their opinions,
‫and we talked about that before.
‫I want you to be independent.
‫I want you to do your own due diligence,
‫your own research.
‫And when analyzing companies again,
‫the last thing you should do,
‫and I mentioned this before,
‫is speak to management.
‫And the reason is because those are
‫the best salespeople in the world.
‫There's a reason they're C level executives
‫and they're earning the big bucks.
‫So be careful when trusting them.
‫And just be very skeptical
‫until all of your research is complete.
‫And so how do you do it?
‫Well, you start off going to sec.gov,
‫and I'll show you all this in a minute.
‫And at sec.gov, you're going to look for
‫something called the 10K.
‫And it's kinda stupid,
‫I don't know why the SEC makes you call it the 10K,
‫but the 10K is basically the annual report
‫or a 200 page document
‫that has to be filed every year
‫by companies that are publicly traded.
‫And it's an awesome document
‫because all the risks that company has by law
‫has to be mentioned in that report.
‫It is amazing.
‫There's background on the management team
‫written up there in the 10K as well, in the annual report.
‫And of course all the financials,
‫and what the company does as well.
‫It's the best primer when you're
‫coming up to speed on any company.
‫So don't rely on Wall Street.
‫Do your own research.
‫Go to scc.gov.
‫Understand what the risks are, too.
‫Understand the market of course.
‫So in this session we're gonna learn
‫how financial analysts on Wall Street model companies,
‫how they analyze sectors,
‫how they assess management,
‫how they get access to information.
‫So let's do this, this is gonna be a lot of fun.
‫So again, there's no theory
‫in this course for the most part.
‫I'm gonna kinda give you reality,
‫how it's really done as I've done this for many years.
‫So let's kick it off with: What is investor relations?
‫Well, every big company has an IR team,
‫or Investor Relations team.
‫And their job is to help you the investor
‫understand the company that you're investing in.
‫And so Microsoft, for example,
‫has an amazing investor relations department.
‫And you can call them up and talk to them,
‫and anybody can,
‫not just the big mutual funds or the big hedge funds.
‫Anybody can, you just have to ask.
‫Remember, Steve Jobs asked.
‫But I don't want you to do that yet.
‫I want you to do all your research first,
‫and at the end of your research process,
‫then pick up the phone if you're still confused
‫and call investor relations.
‫It's their job to help you.
‫They'd be happy to take your call.
‫And that goes for all companies.
‫But smaller companies that are publicly traded
‫might outsource their investor relations.
‫And just go to their websites man,
‫you can figure it out.
‫You can get the investor relations
‫phone number easily there.
‫So when you're building a model,
‫what are the sources?
‫So remember, you've got the exact same accessed information
‫as these Wall Street firms have.
‫And you're probably gonna be
‫better at doing it than they are
‫because you're not biased.
‫The first source is gonna be sec.gov.
‫We've talked about this before,
‫but I wanna go into a little bit more
‫detail now on this one.
‫The second source is the investor relations website.
‫So modeling and valuation is very easy to do.
‫It's a lot of fun and it's a lot easier
‫for publicly traded companies
‫than it is for private companies.
‫Remember when we modeled that private company
‫earlier on in this course it was difficult
‫because we didn't know where to get access to the data,
‫and so we basically just got the total adjustable market,
‫made a bunch of assumptions,
‫and assumed what market share
‫the company would get longer term.
‫And that was revenue.
‫And then we just kinda made assumptions
‫and figured out expenses.
‫Publicly traded companies are a joke,
‫they're so easy to model.
‫And I'm gonna show you how.
‫So we're gonna use Microsoft, ticker MSFT.
‫And we're going to model Microsoft from scratch.
‫I'm gonna show you how to do this.
‫And you can apply this to any company.
‫Doesn't have to be a tech company,
‫it can be any firm that's publicly traded.
‫Let's do this.
‫So the first source is the investor relations website,
‫IR website.
‫So open up your browser,
‫search Google for Microsoft internet investor relations.
‫And you can see on this website
‫you've got all this cool stuff.
‫You've got events, meaning webcasts or web videos.
‫And I used to go up to Redmond,
‫which is in the state of Washington
‫where Microsoft's headquarters are.
‫I used to go up every summer.
‫And I was an analyst at a couple of different funds.
‫And I would go and we would watch Steve Ballmer
‫and Bill Gates present on their thoughts in the next year.
‫What their future product road map looks like.
‫And I got to meet Bill Gates.
‫It was, it was incredible.
‫I was in heaven, I was in heaven.
‫And actually I'm gonna tell you
‫just a quick little story here.
‫Now you have to be aggressive.
‫There was a luncheon at one event
‫at Microsoft headquarters in 2003
‫and 500 people were there, sitting there for lunch.
‫And at Bill Gates table,
‫and each table had about 10 people,
‫there was assigned seating.
‫So of course on his left and on his right
‫were the biggest share holders in Microsoft,
‫the fidelity portfolio manager
‫and the capital portfolio manager.
‫And I thought, "You know what man,
‫"I'm never gonna get a chance like this again."
‫And so I pulled up a chair in between the
‫fidelity portfolio manager and Bill Gates.
‫and I got to sit next to Bill Gates
‫and ask him a ton of questions.
‫And I was in heaven.
‫It was incredible.
‫He was very polite, he was very nice as well.
‫'Cause I think the nature of my questions
‫was a little bit less sophisticated than other investors.
‫But he was very nice about it.
‫But you gotta take these chances in life.
‫Anyway, sorry to digress.
‫It was kind of a cool thing for me.
‫So on the investor relations website,
‫you can get access to these events.
‫So the event I went to
‫is webcast, meaning there's a video showing
‫on the web in real time.
‫And so you get the same access
‫to information that all the big girls and big boys have
‫at the other mutual funds.
‫You can also get past earnings releases,
‫and that sort of stuff.
‫And of course they give you financial information
‫in Microsoft Excel format only.
‫So here we are on Microsoft's website,
‫just search Microsoft and investor relations.
‫And we can click on earnings and financials.
‫And then financial statements.
‫And then you can download an Excel spreadsheet.
‫And many websites have this for you.
‫And you open it up, and you download it,
‫and you can import it into Excel,
‫so you don't have to key in all the historical data,
‫it's already done for you.
‫And so, that's the income saving.
‫You get it from Microsoft and all the financials.
‫Second data source we've got is sec.gov.
‫We've talked about this before,
‫but I wanna talk about it again.
‫'Cause it's so awesome.
‫Go to sec.gov, then you do a fast search,
‫you put in the ticker, which is MSFT, Microsoft,
‫then you type in the annual report,
‫which is 10K.
‫So there's different types of reports
‫remember I told you before?
‫There's the 10K which is the annual report,
‫the 10Q is the quarterly report,
‫and an 8K is a press release.
‫So whenever there's something material
‫or very important happens to the company,
‫they have to disclose it to all investors at the same time
‫through the sec.gov.
‫That's called an 8K.
‫And then there's an S1 which is the document
‫that all companies have to file when they go public,
‫which basically tells you everything you need to know
‫about a company, it's awesome.
‫So here's a 10K for Microsoft.
‫And the cool thing is that you can get the past
‫15 or 20 years from Microsoft for annual reports.
‫It's amazing, just a wealth of data.
‫And this document is super long, too.
‫And so it tells you about the business,
‫the company, the risk factors,
‫legal proceedings, and all that stuff.
‫There's a lot of stuff in it you'll never read,
‫but it's there for ya.
‫You can do a search on the keyword income statement,
‫or select financial data,
‫and get everything you want to know about a company.
‫And by law they have to disclose
‫everything that's important,
‫and every risk as well.
‫It's an awesome resource.
‫And so in this case, I search on the word revenue.
‫And if you're using the Chrome browser,
‫which is way better than any other browser
‫in my humble opinion,
‫if you're using the Chrome browser
‫and you type in the word revenue for example,
‫you see on the vertical scroll bar there
‫all those yellow instances.
‫Those are all the instances of the word revenue.
‫And so it's a context sensitive web-based environment.
‫So you hit control F and you search for revenue.
‫Or you can search for Nokia,
‫which for some reason Microsoft bought.
‫So Microsoft's a big company,
‫growth is slowing, they have to buy growth.
‫That's why they bought Nokia.
‫And you can see that there are fewer mentions
‫of Nokia in the annual report or the 10K,
‫but you can see it there on the vertical scroll bar.
‫So you wanna keep it very simple.
‫Remember less is more.
‫Don't over complicate stuff.
‫So we start off with the basics,
‫like we're building a house.
‫So one brick at a time.
‫And we'll do that.
‫And so like anything in finance or accounting or business,
‫nothing is complicated if you start with the basics,
‫and build on it very slowly.
‫So we'll start off with the basics.
‫So we started off with revenue, of course.
‫And what we did was we just got this
‫from their website directly.
‫We didn't have to key in any of that stuff.
‫Then we add layers.
‫We're building our little Minecraft or Lego
‫or brick-based house.
‫I have kids that love Minecraft,
‫which by the way Microsoft owns now.
‫So now we add the cost to revenue,
‫and that's given to us on Microsoft's website.
‫And if you can't find it on Microsoft's website,
‫you can always go to sec.gov,
‫and open up the 10K
‫and just hard code that stuff in.
‫So modeling is very easy.
‫It all comes down to one simple rule.
‫I know you know what it is
‫because I've mentioned it a million times before.
‫What is it?
‫That's right, everything is just a percent of revenue.
‫Everything is a percent of revenue.
‫Figure out revenue, and the rest of the model
‫is a joke, it's easy.
‫So yes, people make modeling unnecessarily complex.
‫By the way, I don't know if you spell modeling with
‫one L or two Ls, you tell me.
‫It's not hard, it's actually a lot of fun.
‫Attitude is everything.
‫Once you see what percent of revenue
‫every line item is,
‫then you simply look for trends
‫in the historical data.
‫So remember to read financials like a good book.
‫And then what you do after you find those trends
‫is you make assumptions about the future.
‫You're predicting the future.
‫Meaning what percentage of sales
‫each line item is and why,
‫and remember to add lots of comments.
‫This is easy.
‫Let's get back to our Microsoft model now.
‫So here's a little trick for you in Excel.
‫You can name your revenue row,
‫and the way you do it,
‫or name any row,
‫is you actually highlight the row,
‫you see in row eight there I highlight it,
‫and then what you do is you go up
‫and you type the word sales.
‫And you'll see it in a little box up there.
‫See the circle?
‫And then what happens is from now on,
‫you never have to say
‫"Divide a certain line by row six"
‫or whatever it is.
‫You just say "Divide it by revenue,"
‫and it remembers, pretty cool, big time saver.
‫Then we add the cost to get sold,
‫look at the percentage of revenue gross margin is,
‫look for trends over time.
‫And this is still historical data.
‫Now we're putting in the operating expenses.
‫You put it in for each year,
‫you get it directly from Microsoft's website.
‫So we haven't started forecasting yet.
‫And then you put in the rest of the income statement.
‫Remember, everything below EBITs, or EBITDA,
‫is called below the line items.
‫You remember the Swiss companies that make watches
‫that are inferior to our banana watch?
‫I won't use that joke anymore, I'm sorry.
‫So below the line items you put in here.
‫And then you just copy and paste
‫the percent of revenue column
‫below almost every single row.
‫And you can see I put it in red here,
‫and I just made everything divided by sales,
‫S-A-L-E-S, or revenue, same thing.
‫And you can copy and paste,
‫and it will remember which row was sales, it's awesome.
‫OK, great, then you add the YOY percent change row,
‫that should say ROW, or NOW, not sure.
‫So YOY means year over year change.
‫And so I put that in green.
‫And remember, we're looking for trends.
‫You look under the year over year change.
‫And then isn't cash flow and earnings different?
‫No, they're the same thing in the long run,
‫especially with tech companies.
‫And I'm trying to make this whole process easier,
‫and the accounting purists will say,
‫"No Chris, you're wrong because of this."
‫I don't care, I'm trying to make you see
‫the forest from the trees.
‫You might be off by a percent or two in the long run,
‫but who cares?
‫It's close enough for government work.
‫So instead of being able to call stock within
‫one percent or so,
‫use my methodology
‫and you're off by a couple percent in the long run.
‫But it doesn't matter when your target price is 50%
‫above where it is right now.
‫Just stick with me, I'm gonna teach you the basics,
‫an easy way to do everything.
‫'Cause I've made a lot of mistakes in my career.
‫OK, great, what about the balance sheet,
‫the cash flow statement,
‫and the other confusing data that they gave us?
‫Who cares?
‫That's right, who cares?
‫Why?
‫Because the income statement
‫and the cash flow statement
‫are the same thing in the long run.
‫Remember cash flow and that income
‫are the same in the long run.
‫You'll see in my model I didn't include
‫depreciation or non tax items, less is more.
‫Why do we not care?
‫Again, because earnings and cash flow
‫are the same in the long run,
‫and you say, "Whoa, whoa, whoa, whoa, whoa Chris,
‫"Wait a second, wait a second, you're wrong here, man.
‫"What about debt and the cash balance
‫"from the balance sheet?"
‫Well OK, fine, you got me there.
‫If they're huge then we'll add them back
‫or deduct them from our target valuation later.
‫There you go.
‫Great, OK, they're usually not that relevant though,
‫not that relevant.
‫"Wait a second here, Chris,
‫"if you're not including a lot of other stuff in your model
‫"then won't your target price be completely wrong?"
‫No, might be off a couple percent, but who cares?
‫It's only a couple percent.
‫I'm trying to save you time.
‫Let's get back to our model now.
‫We are getting there.
‫We're slowly building this brick house.
‫We got everything now,
‫we got all the historical stuff,
‫and we can make our forecast now.
‫And this is where it gets to be fun.
‫So let's assume for this exercise
‫we're at the beginning of 2015,
‫I'm actually recording this in 2016,
‫but let's assume we're at
‫the beginning of 2015 for this exercise.
‫So as you can see,
‫take a look at that image there,
‫and if you can't read it,
‫if you're using an iPad or something
‫then maybe open it up on a desktop
‫with a bigger monitor.
‫You'll see that all the stuff we're gonna forecast
‫has a little E beside it,
‫2015 E, 2016 E, 2017 E.
‫What does E stand for?
‫It stands for estimates.
‫So let's do it.
‫"Whoa, whoa, whoa, whoa, wait a second, Chris.
‫"I wanna add more detail to on revenues in my model.
‫"I don't wanna just have one line item.
‫"Come on man, Microsoft has a lot more stuff
‫"than one revenue line item."
‫OK, OK, OK, fine, Microsoft gives us a lot more
‫revenue line items.
‫We can get it from their website.
‫You've got their consumer stuff,
‫you've got Xbox, you've got their crappy Nokia,
‫I did write that, yes,
‫their crappy Nokia stuff as well.
‫I don't know why they bought that.
‫Does anybody really use a Windows phone
‫that doesn't work at Microsoft?
‫Exactly, so, we can add that too.
‫And so here is that stuff.
‫I've got all those line items,
‫their revenue and the cost to get sold
‫for each of those line items.
‫You can add that as well
‫if you wanna add more granularity,
‫or information in your model.
‫Well, I'm not gonna do that.
‫I'm not gonna do that
‫because it'll take too much time for today's session.
‫So before we make forecasts,
‫we look for trends in the data.
‫And this is where it gets to be a lot of fun, man.
‫So again, learn to enjoy reading financials
‫like a good book.
‫Understand why revenue grows
‫or contracted historically.
‫Look for patterns,
‫understand financial history as well.
‫So I'll lob one out for you here.
‫Take a look.
‫Why did revenue grow slow in 2001 and 2009?
‫Because we had horrific recessions then.
‫9/11 occurred in '01,
‫and then we had the financial crisis
‫where we were within a bank
‫24 hours of bank machines not working.
‫OK, fine, next up.
‫Why did gross profit decline as a percent
‫of revenue in 2001, why?
‫I think that's 2001, yeah.
‫Well, the reason is,
‫they released the first version of xBox in '01 and '02,
‫and Microsoft is a software company,
‫hence the name Microsoft,
‫but they made this hardware appliance,
‫this big ugly generation one xBox,
‫and it's actually pretty cool,
‫I got it and I loved Halo.
‫But actually they lost billions of dollars on it,
‫billions of dollars.
‫And hardware gross margins,
‫or the cost of making hardware,
‫is much higher.
‫Hardware is not profitable at all, usually, usually.
‫So why did Microsoft do it?
‫Little side talk here.
‫So the reason Microsoft got into this market
‫was because they were worried that Sony,
‫with a PlayStation,
‫would get in your living room,
‫and use your television screen as your computer monitor,
‫therefore eliminating the need
‫to buy a computer longer term.
‫So for Microsoft it was a hedge.
‫And they did incredibly well
‫in this market longer term.
‫But they lost a lot of money.
‫And this is why gross profits
‫were down in 2001 and 2002.