Research of our Financial Strategies Team into the global markets on the one side and research into new funding concepts on the other side build the intellectual knowledge base of Selective Financial Services. This enables us to provide services around securing funding via debt and equity business- and project finance through both, privately and via established financial institutions.

An unparalleled network of global knowledge providers is the heart of our business. We use this collective intellectual capital, specialist sector- and product expertise, and a wealth of experience to support our Relationship Managers and through this, and to deliver the best solution for each client.

Our Financial Strategies Team of researchers and financial analysts contribute deep industry knowledge and situational experience. As a Member of our Financial Strategies Team you conduct research into new and alternative financial strategies and provide unique financial knowledge through solid research into potential opportunities.

As our Financial Strategies Team expands, we seek to associate with the best and brightest financial professionals with energy, personality and drive. As a business analyst you help our Relationship Managers to structure solutions also for the most difficult financial scenarios.

And you can publish your findings! Confidential and most precious information that you have thoroughly researched is published to selective, potential investors and utilized by our Relationship Managers in their daily work.

A Research and Analysis Concept

Every analyst has his or her own way of conducting research and due diligence. There certainly is no one correct way to come to an investment decision. What I am going to describe in this write-up is my personal routine for conducting due diligence. This process can vary significantly based on the business, the project and other factors. Investment approach must be intuitive and adaptive rather than fixed and mechanistic.

Revenue

The first thing you should know about a business is to know how it makes money and how it defines its revenue-producing segments. If you can’t obtain all information on how the business drives its revenue, then it is probably not a good idea to invest. Even further, how a management team divides up a business provides a great deal of insight in to what management thinks is important and how they are situating the company competitively the present and future. If you don’t understand how a business drives revenue then you do not know enough about the company.

What are you doing when you make an investment in a business? You take an ownership stake in a company based on the understanding that the operators of the business will execute a plan to provide you returns on your investment greater than your required return. Therefore, understanding what the operator of the business or project thinks is important and how he plans to compete in the marketplace is very important and should be one of the first things you understand about a business.

An example is Google. It is not completely relevant because Google doesn't segment its business this way. It helps, however, to understand. Google’s main revenue driver is its search and advertising business. You can call this its “bread and butter” or “cash cow”. A cash cow is usually characterized by high margins, solid returns on capital and strong free cash flow, and high barriers to entry. It is a durable competitive advantage. You generally want a cash cow because the large amounts of free cash flow it produces has the ability to organically fund other “growth” segments and areas of the business. Sometimes you get lucky and the cash cow for a business is strong enough and has enough run- way that it is a compelling investment in and of itself. This certainly seems to be the case for Google at the moment as its stranglehold on mobile is only going to get stronger while there are certainly a lot of improvements to make in the area that can provide strong returns. More often there just is not a whole lot of room for growth and improvement. This is when you need the growth segments financed by the “cash cow” to keep pushing the company forward. Assuming that “Google-Glass” division and “Driverless-Car” division are the growth segments for Google. Each division is being financed internally by the free cash flow from the search and advertising business and each is – theoretically – well positioned to lead its respective market. As such it may be considered a catalyst for multiple expansions. This example should give you a good understanding of how the business drives its revenue and a general idea of the way management sees the company competitively based on the way it segments the business.

Positioning

Here we take what we know about a company's revenue drivers and the management’s competitive mindset and judge the viability of each in the marketplace. Every company discloses a list of competitors, but sometimes the list isn’t that good. Even if it is good, we do not take anything at face value. So we have an understanding of revenue drivers and management’s mindset which allows to pick other competitors. After we determine target’s competitors we can begin to get a handle on how a business should operate in this space in respect to competitors and customers.

Essentially you have to ask yourself three questions: How does the market see my target? How do competitors see my target? How do customers see this company? You then have an understanding of how the target is seen from most of the interested parties, namely the market, competitors and customers. While answering these questions you develop an understanding of how the industry works as whole. You start to think about how it is changing and what it may look like in the future.

If you take a step back you will know how the business drives revenue as well as where it is competitively situated. It gives you an idea as to where the industry is headed as well as a general understanding of how management thinks. This way your research has given you the understanding of the target’s competitors. You will know how each competitor drives revenue, as well as how each management team is situating its business going forward.

Management

Why is management so important? When you invest in a business you are taking an ownership stake in the company with the understanding that the operators of the business will execute a plan to provide you returns on your initial investment that are greater than your cost of capital. In order to make an investment you not only need to be confident in management’s plan going forward, but also in the management’s ability to execute that plan in a volatile and perpetually changing environment.

We divide analysis of management in to two areas: Structure and Incentives and Decision-making. By structure of management we look at who makes up the Board of Directors and what each person brings to the table amongst other things as well as the operators of the business and what they bring to the table. Management’s incentive is pretty straight forward. Make sure that management’s compensation structure aligns closely with what a shareholder wants and as well as the time frame for the possible investment.

Analyzing management's decision-making is interesting! Basically these are management’s capital allocation decisions based on realized returns and future positioning. At this point we have an idea of how confident you are in a management team’s ability to execute on its strategy. Industry environments are often changing as is the overall economy and an exceptional management team can do a lot to position a company for continued success and limit downside risk.

Our thesis is to come together and talk with the boss and / or the most senior analyst on the team about what you we have so far. This update is not mandatory or necessary, but it helps.

Financials

What you should do now is to dissect the financials in detail. Basically, you tear the company to pieces line- item by line- item as deep as possible. You go back usually 5 to 7 years. Anything that catches your eye, either good or bad, will go on a list of questions for management that you should have been compiling since the beginning of your research.

By this point you should have a good grasp on the company's accounting procedures and know that there is not any “funny business” going on in regards to the way they report things. This process should also reinforce everything you have learned about their competitive positioning, capital structure, and the way they drive revenue.

Speak with the Management: You should sit down with management and ask them any questions you have summarized. Your Model and Valuation: After management has answered your questions you generally have got a good handle on the business and what is going to happen when going forward. Your next step is to sit down and try to knock out your forward model. It is important to say that you always model each company from scratch. No two companies are the same and you really do get a much deeper understanding if you start from scratch rather than just dropping stuff in a template.

There will be more questions coming up that need to be answered and you will find these an answer to those on the fly as they arise. When it comes to valuation, you need to find a way that works for you personally. A good Valuation Method is a skeleton form: Derive projections from thesis, Stress –test projections, and derive range of values for the business. Finding the exact valuation for a target is not main priority. It is a reasonable range of value for a given set of operating scenarios. The take on value is not very complicated. Value is a product of: Growth, Returns and Cost of Capital. More important than a scientific and precise valuation is that you understand what is going to cause the market to realize the intrinsic value of the asset and that you get the timing of the catalyst correct. If you’re too early you can get forced out the trade before anything materializes for any number of reasons. If you’re too late you’ve lost some upside at the very least.

Find the search for the “correct” cost of capital to be in the gentlest terms a fool’s errand. The best investments are not made because you nailed the discount rate in percentage terms and if making an investment decision comes down to whether you go with a 10% or 12% discount rate. In that case with almost absolute certainty, it won’t be a good investment.

It is helpful to know what discount rate the market is implying when looking to make an investment. Approximating a required rate of return is mostly a way to keep investment risk at the forefront of your mind. Risk is anything from macro on down to the guy and girl on the other side of your trade. Often, you may start with the market - implied discount rate and then adjust it based on everything from macro factors to industry and company factors and finally to the generally psychology of the other market participants.

It is important to understand that at any point in time a single driver of value can dominate the others. If we look back, in the tech bubble growth was the main driver of valuations and returns fuelled the housing bubble. Today risk is the driver of the current bull market. With liquidity being pumped in to the market and treasuries at rock-bottom yields it seems as though investors have re-priced risk in the search for return.

Conclusion

Most anyone can break down some financial statements or slap a value on a business. To do well you need to be able to time inflection points, properly handicap the risk and reward scenarios. It is also important to determine the appropriate cost of capital for the risk profile of the investment. Each of these is extremely difficult in practice. A good feeling comes with experience. Risk includes everything from macro to the others in the market. It is likely you are not going to be able to pick these things up overnight or even in a few market cycles.

Inexperience isn’t damning for a young guy or girl in the business. If you work hard, stay humble, and make a point to be intellectually honest you’ll likely be all right.

Professionals working for a common goal !

This report provides information on opportunities within the Selective Financial Services organisation. It reveals how a members of Selective Financial Services work for the common goal – to find that perfect solution to any financial challenge. A Broker can advance to be Relationship Manager. People with passion for research look into financial markets in their own way and publish findings to an influential international financial audience. The Financial Strategies team uses this basic research in their day to day work. Investors interested in project funding play an important role in the organisation as well as providers of new financial concepts. The Research Team of Selective Financial Services sends you the free copy of the original report if you select R8 here.