Modeling in valuation.
Congratulations.
You're now on the green stage or the fifth stage you're in year 7 to 8.
You're to go public very soon.
OK.
And we're going to deal with Goldman Sachs and maybe Morgan Stanley.
It's going be a lot of fun.
But before we do that you're going to play the role of the financial analyst OK so how do Wall Street
analysts make financial models and how they value companies.
So you're not going to be a student anymore today.
That's right.
You're you're you're a financial analyst you work on Wall Street.
OK.
So you will learn exactly how Wall Street analysts work or what their secrets are and how they do due
diligence how they model companies and a good analyst doesn't need others to form their opinions.
We talked about that before.
I want you to be independent OK when you do your own due diligence your own research and when analyzing
companies.
Again the last thing you should do before is speak to management and the reason is because those are
the best salespeople in the world there's a reason they're sea level executives and they're earning
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 knock off and I'll show you all this in a minute.
And at SCC dot gov you're going to look for something called the 10-K and it's kind of stupid.
I don't know why the FCC makes you call the 10-K but the 10-K is basically the annual report or a 200
page document that has to be filed every year by companies 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.
OK.
There's a background of the management team written up there in the 10-K as well in the report.
And of course all the financials and what the company does as well it's the best primer.
When your current speed on any company case so don't rely on Wall Street do your own research go to
FCC to understand what the risks are to understand the market of course.
So in this session we're want to learn how financially some 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 actually a lot of fun.
So again there's no theory in this in this course for the most part.
OK.
I'm going to kind of give you a reality how it's really done as I've done this for many years.
OK.
So let's kick it off with what is investor relations.
Well every big company has an eye on our 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 have to ask.
Remember Steve Jobs ask.
But I don't why you do that yet.
I want you 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.
OK.
They'd be happy to take your call.
And that goes for all companies.
OK.
But smaller companies that are publicly traded might outsource their Investor Relations and just go
to their Web sites man you can you can figure it out.
You can get the investor relations phone number easily there.
OK.
So when you're building a model one of the source.
OK.
So remember you've got the exact same access information as these Wall Street firms have.
And you're probably getting better at doing it than they are because you're not biased.
The first source is going to be FCC dog.
We've talked about this before but I want to go into a little bit more detail now on this one.
OK.
The second source is the best relation's website.
So modernly evaluation is very easy to do.
It's a lot of fun and it's a lot easier for publicly traded companies as it is for private companies.
Remember we model that private company earlier on 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 addressable 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 kind of made assumptions of build out expenses kept publicly traded companies are a
simply a joke.
They're so easy to model I can show you how to.
So we're gonna use Microsoft ticker MSF T.
And we're going to model Microsoft from scratch.
I can show you how to do this and you can apply this to any company.
It doesn't have to be a tech company to be any firm as publicly.
OK.
Let's do this.
So the first source is the Investor Relations Web site.
OK.
Our Web site.
So open up your browser search Google for Microsoft Investor Relations.
And you can see on this Web site you've got all this cool stuff.
You've got events meaning webcasts or web videos and I used to go up to Redmond's 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 fonts.
And I would go and you know we would watch Steve Balmer and Bill Gates presents on their thoughts for
the next year.
You know what the future product roadmap looks like.
And I got to be Bill Gates.
It was it was incredible.
I was in heaven.
And actually I can tell you a quick little story here.
But you have to be aggressive.
There was a luncheon at one one event at Microsoft quarters in 2003 and 500 people were there saying
they're for lunch and at Bill Gates table and each table had about 10 people there was assigned seating
so of course on his left not his right we're the biggest shareholders in Microsoft.
Right.
The fidelity portfolio manager and the capital portfolio manager.
And I thought you know what man I'm never 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.
I mean it was it was incredible.
He's very polite he's very nice as well because I think the nature of my questions was a little bit
less sophisticated investors but he was very nice about it.
But you've got to take these chances in life now.
Anyway I digress.
It was kind of a cool thing for me anyway.
So on the on the Investor Relations Web site you can get access to these events the event he went to
is webcast meaning there's a video shown on the web in real time.
And so you get the same access to information that's all the big girls and big boys have that the other
mutual funds.
OK.
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.
OK.
So here we are on Microsoft's Web site.
Just search Microsoft in Investor Relations.
OK.
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.
OK.
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 this or that sort of them for you.
And so that's the income statement you get it from Microsoft and all the financials.
OK.
Second data source we've got is we've talked with before but I want to talk about it again because so
us can go as you see.
Then you do a fast search.
You put in the ticker which is MSFC Microsoft then you type in the annual port which is 10.
OK so there's different types of imports from told before there's a 10 k which is the annual report
the 10-Q is a quarterly report and an 8 k is a press release.
Right.
So whenever something material or very important happens at the company they have disclosed all investors
at the same time as he said.
That's called a cap.
And then there's an S-1 which is the document that all companies have to file when they go public which
basically tells you everything needs to know about a company.
It's awesome.
OK.
So here's a 10-K for Microsoft and the cool thing is that you can get the past 15 or 20 years from Microsoft
for annual reports at the Macy's a wealth of data and this stock is prolonged too.
Right.
And so it tells you about the business the company the risk factors the legal proceedings and all that
stuff there's a lot of stuff that you'll never read but it's there for you.
You can do a search on the keyword income statement or select financial data and get everything you
want to know about a company.
Right.
And by law they have to disclose everything that's important and every risk is well.
It's an awesome resource.
Right 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 my humble opinion
if using the Chrome browser and you type in the word revenue.
For example see the vertical scroll ball bar there all those yellow instances those are all the instances
of the word revenue.
OK.
And so it's a context sensitive web based environment.
So you hit control f and you search forever.
Or you can search for Nokia which for some reason Microsoft bought So Microsoft's big company growth
is slowing growth by growth that's why they bought Nokia and you can see that there are fewer mentions
of Nokia in the report or the 10-K but you can see it there on the vertical scrollbar.
OK.
So you want to keep it very simple remember less is more.
Don't overcomplicate stuff.
So we start off with the basics right like we're building a house.
All right so one brick at a time and we'll do that.
And so like anything it fights or counting or business nothing is complicated if you start with the
basics and build very slowly.
OK.
So those are off the basics.
So we start off with revenue of course.
Right.
And what we did was we just got this from the website directly we have to keep an eye on that stuff.
All right then we add layers right we're building or little Minecraft or Lego or brick based house.
I have kids at love Minecraft which by the way Microsoft owns now.
OK.
So now we add the cost of revenue.
Right.
And that's given to us on Microsoft's website.
And if you can't find on Microsoft's Web site you can always go to all of the 10-K and just hard code
that stuff in Somali's very easy.
It all comes down to one simple rule.
I know you know what it is because I've mentioned 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 the models show it's easy.
All right.
So yes people make modeling unnecessarily complex by the way I don't know if you spent modeling with
one or two elves.
You tell me OK.
It's not hard.
It's actually a lot of fun.
Attitude is that.
OK once you see what percent of revenue every line item is then you simply look for trends in the historical
data.
Right.
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.
Right.
You're predicting the future to meaning what percentage of sales each line item is and why.
Remember add lots of comments.
OK.
This is easy.
OK.
Let's get back to Rome actually Potala.
So here's a little trick for you.
So you can name your revenue Roe and the way you do it or in any row right is you actually highlight
the case 0 8 there highlight and then what you do is you go up and use the word sales.
You'll see it in the mail box up there right to the circle.
And then what happens is from now on you never have to say you know divide a certain line by you know
row 6 or whatever it is you say divided by revenue and it remembers.
Recall big time.
OK.
Then we add the cost of goods sold.
Look at the percentage of revenue gross margin is for trends over time correct.
And this is still historical data.
Now we're putting the operating expenses right.
You put it in for each year you get it direct with Microsoft's website.
Right.
So we haven't sort of forecasting it.
Okay.
And then you in the rest of the income statement member everything below Ebbets for you but da is called
below the line items right member of the Swiss Swiss company the make watches that are inferior to our
brand or what.
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 now.
And you could see a pattern read here.
And I just made everything divided by sales as Aliase revenue same thing.
And you can copy and paste and or member which row a sales tax.
Okay great.
Then you add the y o y percent change Roe.
That should say are O.W. to or now wouldn't matter.
So why or why it means your year change.
And so I put that in green and remember for trends.
Okay you look at the year of year change.
Right.
And then isn't cash flow and earnings difference.
No it's 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 will say No Chris you're
wrong because of this.
I don't care.
OK.
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 be able to call stock within you know it you know with a 1 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
percent above where it is right now.
OK.
Just stick with me I'm going to teach you the basics an easy way to do everything.
OK.
Because I have a lot of mistakes my career.
OK great.
What about the balance sheet the cash flow statement and the other confusing did they gave us.
Who cares.
That's right who cares.
Why.
Because the income statement the Cashell statement is the same thing in the long run can never cash
flow and negative the same in the long run.
You'll see in my model I didn't include depreciation or nontaxable.
Less is More.
Why do we not care.
Again because it is cash for the same long run and you say whoa whoa whoa whoa whoa Chris wait a sec
wait a sec you're wrong here man.
What about debt and the cash balance the balance sheet.
Well OK fine you got me there.
If they're huge them or add them back or deduct them from our target valuation later.
OK.
There you go.
Great.
OK.
They're usually not that relevant but they're relevant.
OK.
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 half a percent.
Trying to save you time.
Let's get back to remodel now we are getting there we're slowly building this brick house.
OK.
We've got everything now.
We got all the historical stuff and we can make our forecast now.
OK.
And this is where it gets to be fun.
OK.
So let's assume for this exercise were the beginning of 2015.
OK.
It's actually I'm actually recording this in 2016.
But let's assume we're at the beginning of 2015 for this exercise.
OK.
So as you can see take a look at the image there.
And if you can't read it on if using an iPad or something then maybe open up on a desk top with bigger
monitor.
You'll see that all the stuff we're going to forecast has a little e beside it.
2015 doesn't 60 70.
What does it stand for.
Stands for estimates.
OK let's do it.
OK.
Well wait a second Chris I want to add more detail on revenues my model.
I don't want to just have one line item.
Come on man Microsoft has a lot more stuff that will let revenue line up.
OK OK OK fine.
Microsoft gives us a lot more revenue line item to get it from the Web site you got there consumer stuff
you 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.
OK.
So we can have that too.
And so here is that stuff.
I've got all those line items the revenue and the casket sort of resells linens.
You can add that as well if you want to add more granularity or information your model.
I'm not going to do that.
I'm not going to do that because I'll take too much time for today's session.
OK 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.
OK so again learn to enjoy reading financials like a good book.
OK.
Understand why revenue grows or contracted historically look for patterns.
I understand financial history as well.
So a lot went up for you here.
Take a look.
Why did revenue growth slowed 2001 in 2001.
Because we had horrific recessions then 9/11 occurred in 0 1 and then we had the financial crisis where
we were within 24 hours.
Banks is not working.
OK fine.
Next up why did gross profit decline as a percent of revenue in 2001.
Why.
Right.
I think this has
Well the reason is they released the first version of Xbox.
No wonder no to.
And Microsoft is a software company named Microsoft.
But they made this hardware appliance right.
This this big ugly generation X box and it's actually pretty cool.
I got it and I love Halo but it actually they lost billions of dollars on it.
Right.
Billions of dollars in 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.
Lowside talk here.
So the reason Microsoft got into this market was because they are worried that Sony with the Playstation
would get in your living room and use your television screen as your computer monitor.
Therefore eliminate the need to buy Computer longer term.
So for Microsoft it was a hedge.
And they do 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.