Market News with Rodney Lake is a regular program of the GW Investment Institute to discuss market news and key investing concepts.
For the first show of 2022, I focused on the semiconductor industry. Semiconductors are essential for many products, such as: computers, phones, gaming consoles, medical equipment, cars etc. and therefore their demand skyrocketed during the COVID-19 pandemic. There were a record number of semiconductors sold in 2021, but they also faced supply chain issues and there was an increase in their cost partly due to these issues and also the increasing rate of inflation.
After talking about the economy through the lens of semiconductors, I shared some information about the countries dominating the semiconductor industry. I then discussed company specific news specifically around consolidation in the semiconductor industry and companies trying to increase their manufacturing capacity in the United States and ended the show with Q&A.
Below you can watch a replay, or listen to the podcast.
I hope that you enjoyed the show. If you have any feedback or ideas for future shows, please let me know by writing invest@gwu.edu.
The GWII taught four classes this semester, hosted 14 different industry professionals for guest lectures, presented three shows of “Live with Rodney Lake” to discuss market news, released two quarterlyreports, and culminated the semester with four student pitch days. Thank you to all of our students, guest lecturers, alumni, donors, and everyone who helps to make the program a success.
An important part of our program are the stock pitch days – a students final project where they examine their outlook for an industry and research companies using the GWII framework (business, management, price vs. valuation, and balance sheet) ultimately proposing to sell a current holding in the portfolio which will fund the purchase of a different company that the student believes is a better long-term investment.
For Spring 2022, the GWII will be teaching the following classes: Phillips Student Investment Fund, Quant Student Investment Fund, Venture Capital class. Additionally, Professor Lake will be teaching Business Leader Career Strategy course and Undergraduate Research course. We hope everyone has a great break over the holidays and look forward to seeing everyone back on campus in January.
If you have followed the GWII Investment Framework: BMPB blog series, thank you, now it’s time to assemble the components:
analyze the Business,
evaluate the Management,
estimate the Price vs. the Valuation, and
research the Balance Sheet.
Score each BMPB framework component from 1 – 10. To calibrate the scores, a 10 is the best in the category. For example in the business component a score of 10 is the best business you can find, high profit margins, great brand, and has many opportunities to reinvest capital at high rates of return. A score of 5 is an average business, and a 1 is a terrible business. This score is what you the analyst will assign in the open box in the below table. Weight each component of the framework 25% and derive a composite score for the company, i.e., a weighted average. Refine your score as many times as you think necessary (hint more than once). Being consistent with the system is important. After you have scored more than one company you may compare these scores, to be clear a higher score implies a higher degree of confidence.
GWII Investment Framework: BMPB
Component
Score (1-10)
Weight
Brief Description
Business
25%
Analyze: What’s the company’s business model? How do they make money? What products and/or services do they offer? In what geographic regions do they operate? What’s their Return on Equity (ROE), using the Dupont Formula ROE = Profit Margin x Asset Turnover x Equity Multiplier. What’s their revenue growth rate? What’s the change in their profit margin over time? (see GWII Investment Framework, BMPB – Business blog post)
Management
25%
Evaluate:To evaluate management use the acronym CAPITAL – Capital Allocation; Preparedness; Incentives; Track record; Alignment; Long term.(see focus on management blog post)
Research:Work to understand the company’s credit rating and balance sheet structure. What’s the risk level of the company’s capital structure? (see How do you get confidence in a balance sheet? blog post)
Composite Score (weighted average)
100%
Note: Your composite score should reflect all the work you have put into your overall analysis.
This elemental structure, BMPB, provides you with a basic tool to evaluate many different investment opportunities. The BMPB investment framework has served us well since 2005 and continues to do so. We work to consistently refine and improve our process and analysis. Continuous improvement is a core feature of what we do. Thank you for taking the time to read about the GW Investment Institute’s Investment Framework.
GWII Investment Framework: BMPB, Business, Management, Price vs. Valuation, and Balance Sheet,
GWII BMPB – Balance Sheet
When you analyze a company’s balance sheet you may think, step one – check the debt level, step two – consider if that debt level is acceptable, and step three – done. To conclude your analysis at this point oversimplifies the work and increases the probability that you have missed something. So as an analyst what should you be looking for? Aim to find a balance sheet that provides you with confidence especially when the economic environment becomes challenging.
How do you get confidence in a balance sheet? Start by partnering with a management team that is not taking unnecessary risk with the balance sheet. The most significant risk for any company is the risk of going out of business. One way to dramatically reduce the probability of going out of business is to not over-lever the balance sheet, this does seem obvious, however, sometimes it’s been missed. The management should be doing some basic asset-liability matching. An example of potentially taking too much risk is significantly levering up the balance sheet to do an acquisition, avoid these situations. Another practice that should at least give you pause is when a management team issues net debt to pay dividends. This is a potentially damaging practice, it serves current shareholders interests at the expense of the company’s long term prosperity – this is not sustainable.
Further, the balance sheet is one indicator of the financial discipline of management – an interconnection with the BMPB framework. Having net cash on the balance sheet is a good thing, don’t over optimize. As an analyst you want to understand how management thinks about the use of leverage. Review and analyze how management navigated periods of economic stress, e.g., the financial crisis in 2008-2009, covid-19 2020-2021. Did they raise cash when they could – prior to the stress period, or when they had to – during the stress period? This pandemic is an example of how things can happen outside of our control, we cannot predict the specific events, we can however, prepare – this is also from our management analysis. Did the management team prepare the balance sheet for difficult times. Difficult times will arrive at one point or another, our management teams need to have the business and balance sheet ready.
Metrics to use to evaluate the balance sheet: Interest Coverage Ratio / Time Interest Earned (EBIT/Interest Expense), Debt to Equity, Quick Ratio (cash and cash equivalents + marketable securities + accounts receivable/current liabilities). We’ll review more about metrics another time.
Your analysis should include the consistency of the company’s cash flow. For example, matching a cyclical business with a highly leveraged balance sheet can be a design for failure. Contrast that example with the consistent cash flow of a consumer staples company, example, Procter & Gamble (PG), its cash flow tends to be fairly consistent across economic cycles, therefore having some debt on the balance sheet is much more tolerated in times of economic stress. This is basic asset – liability matching.
If the company does have debt, put in the work to understand the company’s credit rating and the structure of the debt. Is the company’s credit rating: investment grade, high yield, or not rated? When is the debt due? All at once? Over time? What’s the interest rate? Is it fixed rate? Is it floating rate? What are the covenants? Understanding a company’s credit rating and the structure of its debt will provide you with a better view of the company’s overall risk profile.
To better understand the balance sheet will require more time and attention, we’ll continue in a future post, stay tuned. Our GWII Investment Framework series will continue and our next post will be a summary of the GWII Investment Framework: BMPB.
To say that the market has been a bit all over the place since the start of 2020 would not quite be descriptive enough. Along with the market the GW Investment Institute (GWII) Student Investment Fund portfolios have risen, fallen, and risen back again, let’s see what’s next. While the investment environment continues to be highly uncertain, principally driven by what impact COVID-19 will have moving forward, we continue to move forward with our work at GWII to educate and train our students as well as research and development. We aim to help our students become better investors and better business people.
Our students have worked diligently and we are proud of their work. Our first official quarterly report is for the period ending June 30, 2020. In the past we have posted GWII data on an ad hoc basis, however, moving forward we look forward to providing you with these quarterly reports.
