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Project “Buy, Sell or Hold” Memo
Highly polished, a two-page buy, sell, or hold memo lay out the student’s stock investment selection strategy. The memo must be brief, complete, and to the point. Using newspaper style columns, and a font size no smaller than Times Roman 10 point, memo may cover no more than two sides of one sheet of paper, including all charts, graphs, footnotes, and so on.
A “buy” selection is the student’s choice of the most “undervalued” stock; a “sell” selection is a description of the student’s preference to short the most clearly “overvalued” stock. A “hold” selection memo reflects a student’s discussion of a favorite stock that may be fairly valued at the moment, but would warrant investment at a specified lower price. In the memo, students respond to the question: Which stock will outperform over the coming 3-5 year time frame? Which stock will underperform over the coming 3-5 year time frame?
Underlying assumptions must be made explicit. Memo must fully describe the company selected, price targets, risk characteristics, the industry and investment environment and so on. Why is this a good (or bad) idea now? What do you see that other investors fail to grasp? Be sure to compare the historical accounting performance of your buy, sell, or hold selection with relevant market data and from industry competitors. For example, if you believe that the rate of return on stockholders’ equity is the best available accounting measure of firm performance, your “buy” selection should have a very high ROE relative to the DJIA and industry competitors. Conversely, a “sell” selection should have a ROE that is mediocre. Is this historical accounting performance a good predictor of future performance? If a turnaround is in the offing, why did the business deteriorate so badly in the first place?
Student-analysis must anticipate and respond to the legitimate concerns of potential buyers and sellers of the stocks recommended for purchase or sale.
The written memo outline provided below may prove helpful in offering some structure to your analysis. The risks and potential rewards of the chosen investment strategy must be carefully described and documented.
Written memo outline
Stock selection: Select a promising company from an attractive industry. Clearly explain why this is a good business run by capable management. If not, identify the catalyst that will transform the company into a good business run by capable management.
Substantiate that this is a superior business selected from a superior industry.
Promising industries as defined by conventional industry criteria (see Yahoo!, Value Line, etc) should be identified. A review of historical performance and projections for the future should be limited to five-year intervals.
Characterize industry growth and compare it with growth in the overall economy. Identify and carefully evaluate historical and anticipated changes.
Compare company and industry historical results against the market.
Use accounting information to evaluate profitability. Profitability measures: ROA, ROE, EPS, profit margin, Cash flow, free cash flow, etc.
Describe industry barriers to entry that are apt to shield the firm from competitor growth or new entry. Focus on firms with unique capabilities apt to yield durable long-term benefits.
Use accounting information to evaluate historical growth and growth prospects. Growth measures; sales growth, EPS growth, book value growth, cash flow growth, etc.
Confirm that this is a superior business selling at an attractive stock-market valuation.
Consider traditional valuating measures for tangible assets: P/E, P/B, P/Sales, P/Cash flow, etc.
Consider hard-to-measure intrinsic value measures. Does the company command valuable intangible assets? Look at the value of brand name recognition, research and development capital, patents, copyrights, etc.
How risky is the company? Consider beta, leverage, dividend yield, dividend payout ratio, 52-week high-low, etc.
Selection Criteria: select a stock in a company with superior business characteristics that is apt to reward shareholders with superior rates of return. Don’t even think of buying a stock for 5 minutes if you don’t want to own it for 5 years. To convince the reader that you have made an appropriate selection, make sure the reader can answer in the affirmative to each of the following questions:
Is this a wonderful business?
Look for rates of return on total capital.
Make sure that earnings show up in the form of cash.
Does the company management make wise use of leverage (i.e., avoid it)?
Look for rates of return on stockholder’s equity that exceed 20% per year. Be cautious about companies with rapidly growing debt?
Does the company enjoy attractive growth opportunities? Look for earnings per share growth of at least 10 % per year. Be careful about companies operating in industries with hyper growth.
Does the company enjoy barriers to entry? Look for castles with big moats. Castle size is less important than moat size and depth. Companies that create and maintain their own moat are the best.
Does capable, shareholder-motivated management run the company?
Year in and year out, does company performance meet shareholder objectives? Quality management is reflected in quality performance (i.e., ROE is high and the stock price goes up).
Does management own a significant percentage stake? Be circumspect when management owns too small stake in the company.
Is managerial compensation determined by performance?
How did management come to own its stake in the company? Look for the companies where management is buying shares in the open market.
Are any institutional investors on board? Have large investors recently taken an important interest in the company? Check SEC reports on EDGAR.
Is the company stock selling at a reasonable price?
When you purchase a share of common stock, you are buying part of business. Why would the share price deviate from the intrinsic economic value of the business?
Look for consistently high profit companies selling at relatively low P/E ratios. Value of ROE ratio, ROE/PE should be high. VRE >1 (okay to buy).
Look for high EPS growth companies selling at relatively low P/E ratios. PEG ratio, PE/Growth, should be low. PEG<1 (okay to buy).
Investment Strategy: Here the analysis is synthesized into an investment strategy.
How much is the stock worth? Why is the stock underpriced (or overpriced)?
For whom is the stock an appropriate investment? Conduct a detailed rick analysis under various market environment scenarios. How will you know if you are right? How will you know if you are wrong?
Written Project Evaluation Evaluation Criteria:
Completeness Clarity, appropriate use of graphs and charts. Originality—Is new insight offered? What is everyone else missing? Why is the market consensus wrong? Professionalism—does the project development meet high professional standards? Are information sources carefully cited and footnoted? Could I take this memo to a tough job interview and get the job?
All written projects turned in for this course represent original independent work. Especially important is the need to document original sources of information relied upon, and to give proper credit to anyone who helped you with your written project. Footnotes must be complete and informative. The purpose of footnotes is to help the reader assess the write’s independent contribution to the written matter in the question, and make it quick and easy for the reader to consult original sources for more detailed examination. If you benefited from the helpful comments or editing input of others, thank them in your footnotes.
The issue of digital plagiarism has raised concerns about ethics, student writing experiences, and academic integrity. KU subscribers to a digital plagiarism detection program, which may be used to check papers submitted in this course.