IBanking Interview Prep

I. Qualitative Questions

Walk me through your resume…

The majority of interviews will start out with you being asked to introduce
yourself and your background or “walk me through your resume.”  There are
two reasons for this.  First, the interviewer wants to hear your “story”
and second, it gives the interviewer a chance to quickly read over your
resume while you are talking.  More often than not, he or she hasn’t had the
time to read it before you walked in the interview room.

The opportunity to walk through your resume is your chance to talk about
your background and to make your case why you want to be an investment
banker.  The most important thing is that you tell a story that makes sense to
the interviewer and shows a progression leading up to you being a banker. 
Even if the choices that you’ve made (schools, degrees, jobs) don’t follow a
natural progression, you need to describe your experiences in a manner that
flows convincingly.  Now, that isn’t to say that you necessarily need to find
commonality in everything you’ve done, or “weave a thread” through each
job, as long as you can demonstrate some sensible flow.  For example,
highlight how each job enabled you to take more responsibility or required
more finance knowledge than the one before it.  Even if you’ve switched
careers or reversed directions, talk about what you’ve learned from those
decisions that make you a good investment banking candidate.

Remember, this is your opportunity to make a first impression and perhaps

your only opportunity to make your case as you see fit, so don’t
underestimate the importance of this part of the interview.

If I am asked to “walk through my resume,” where (when) should I

start?
It’s really up to you and whatever you think tells the best story.  Some
people start with where they grew up.  Others start with college or their first
job out of college while more experienced or older individuals might start
with Business School or other graduate program.  Just keep in mind that
your most recent experiences are going to be more relevant so don’t get
bogged down with stories of your first lemonade stand or how well you
invested your Bar Mitzvah money.

How long should I spend “walking through my resume?”

You should plan on spending 3 – 5 minutes talking about your background. 
If you notice that the interviewer looks bored, then speed it up.  If the
interviewer looks engaged, then be more detailed.  Some interviewers will
let you finish your story before asking questions and others will interrupt
you repeatedly.

While “walking through my resume,” can I refer to the copy of the

resume in front of me?
No.  Even if you have a copy of your resume in front of you, you should be
able to talk about your background and experiences without referring to your
resume.  Referring to, or worse, reading off of your resume makes it seem
like you don’t even know your own history.

Why do you want to be an investment banker?

As someone trying to break into the industry, this is the most important
question that you can be asked.  And even if you are not asked this
explicitly, other questions will likely try to elicit from you the same
information.  Most people trying to get a banking job have the intellectual
abilities to be a banker.  The question is do they have the attitude, the
mindset, the willingness to sacrifice and the attention to detail.  There are a
range of answers that will help you portray that you have both the ability and
attitude to be a banker.  Here are a few:

- I’ve always enjoyed the aspects of my past jobs/classes in school that

involve corporate finance.- I like the fast paced environment of banking as
I’ve always excelled in pressure situations.- I am excited to be able to work
on many projects at the same time and the fact that I’ll never be bored.- I
can’t wait to be in an environment where I’ll always be learning.- Even
though I know I’ll be playing a junior role for a number of years, I like that
ultimately I will be able to help advise senior management of companies.-
I enjoy reading about M&A transactions in the newspaper.- All of the
bankers that I have met are really smart and I want the opportunity to work
with them and learn from them (just make sure you say this one with a
straight face)

Whatever responses you give, make sure that you can back them up with
actual stories and details from your experiences.

How NOT to answer the question, “Why do you want to be an

investment banker?”
I want to make a lot of money/I want a house in the Hamptons/I want to date
models, etc.Yes, everyone in banking is in it for the money.  Anyone who
says otherwise is delusional or lying.  But, you still can’t say it in an
interview.

I love working all night…Yes, you can say you want to be challenged.   But
NOBODY likes working on pitchbooks at 3:00 am and you won’t either.

I want to learn how businesses work so I can advise CEOs.Two issues here. 

First, the typical banker knows (a little about) finance but nothing about
operations and how businesses really operate.  Second, as an Analyst or
Associate, it will be years before you will be advising CEOs, if ever.

Why do you want to work at our bank?

This is your opportunity to (1) show you know a little about the bank and (2)
kiss the ass a bit of the person with whom you are interviewing. Just don’t
go overboard with #2.

If you have friends that work for this bank, say so, and mention that they are
really enjoying their experiences.  If you are interviewing with a bulge
bracket bank, mention how you are excited about the prospect of getting a
broad experience and learning about different products or industries.  If you
are interviewing with a boutique, talk about how you like the idea of a
smaller firm, where you might have more responsibility and more interaction
with clients and senior bankers.  Without a doubt (unless this is the first
person with whom you’ve ever met), state how you’ve really liked all of the
people from this bank that you’ve met before.

If you have previously had the opportunity (for example, in prior interviews
or at recruiting receptions) to ask other bankers from this firm (or better
yet, this particular interviewer) why they like working at this bank, then by
all means recycle these answers!  If they say the culture is great, you say you
want to work here because the culture is great.  If they say dealflow is
strong, you say you want to work here because the dealflow is strong.  You
get the idea…

What do you know about our bank?

Somewhat similar to the last question (Why do you want to work here?), you
need to demonstrate your knowledge of the bank.  You might talk about a
deal or two that you’ve heard or read with which the bank has been
involved.  Or, if you know the bank is strong is certain product areas (such
as M&A or leveraged finance) or industry coverage, then mention that. 
Perhaps the bank focuses on cross-border deals or deals in emerging
markets.

By no means will you be expected to be an expert but you should be able to

talk about a few things.  If you don’t know anything, rather than make
something up and sound stupid, be honest.  Say something like, “I really
don’t know many specifics, and one of the reasons that I’m really excited to
interview with you is to learn more.”  If you can ask the interviewer about
the bank, then you can learn some things for your next interview, for when
you are asked the same question.

What are your strengths?

This is one of those generic interview questions that you are less likely to get
in banking interviews.  If you do get this question, this is one of your best
opportunities to make your case that you’d be a good banker.  Some of the
skills that you probably want to highlight include your
analytical/quantitative skills (especially for an Analyst), communication
skills (especially for an Associate), ability to learn quickly, detail
orientedness and ability to work really hard.  You should definitely be
prepared to back up what you state as your strengths, using one or two
concrete examples from past jobs or school.

What are your weaknesses?

Even more so than the question about strengths, it’s unusual to be asked
about your weaknesses.  There is no good way to answer this question so the
best advice is to try to move on as quickly as possible.  Obviously you don’t
want mention real weaknesses (I’m dumb, I’m lazy, I require 12 hours of
sleep a night).  You also don’t want to say things that make you look
silly like “I work too hard” and you can’t say you don’t have
any weaknesses because you’ll come off as too arrogant.  So try to think of
something relatively innocuous that also might highlight a strength.  For
example, “I can get occasionally get impatient with peers/coworkers who
don’t have the same abilities as me or don’t show the same commitment that
I do.”  Or, “Sometimes I can be so focused with or driven by the task on
hand that I wind up tuning out other aspects of my life.”  You can also
usually say something like, “I think my skills are very good compared with
my peers but, of course, I’m new to investment banking, and I obviously
need more experience.  Experience which I’m confident I’ll get working for
you…”

Occasionally, a really difficult interviewer will ask you for 3 weaknesses,

knowing that your first 2 will be bullshit answers.  To which I would
respond that my major weakness is, “I’m really bad at bullshit interview
questions.”

What are your long-term plans?

This is a bit of a tricky question.  You obviously want to demonstrate you
are committed to investment banking but you don’t want to come across as
obviously disingenuous by stating that banking is the only job you’ll ever
want to do.  If you are interviewing for an Analyst position, I don’t think you
need to be committed to banking for the long-term (since being an Analyst
position is a 2-year position).  I would mention that you are really
excited about and committed to becoming an Analyst and that you want to
learn as much as possible, get as much experience, etc. while you are an
Analyst.  But I think it’s okay to say that you’ll see what happens after your
Analyst position is up (i.e. going to business school, moving on to other jobs
like private equity or hedge funds, etc.)

If you are interviewing for an Associate position, then you need to

demonstrate a little bit more commitment to banking.  I would definitely
recommend stating that you see yourself as a banker for the foreseeable
future (call it 3-5 years).  However, I don’t think that you need to state that
you are certain to be a banker for the rest of your life but I wouldn’t say that
that is out of the question either.

With what other banks are you interviewing?

Interviewing is about marketing yourself and you do want to give them
impression that you are desired by other banks.  On the other hand, you
don’t want to lie.  Always keep in mind that banking is a small industry
where bankers know bankers at other banks.  If you are interviewing with
other investment banks say so.  If they are prestigious or comparable to this
firm, name them.  If they are less prestigious, then just mention that you are
interviewing with “a number of boutiques.”  If they ask you to name them,
then mention one or two.  If you have no interviews lined up, state that you
are “talking to a number of banks” and try to move the conversation along.

Are you interviewing for jobs other than investment banking?

This can be another tricky one.  If you are interviewing out of undergrad or
B-School, I would emphasize that you are only interviewing with investment
banks or at least that banking is by far your main focus.  If you are trying to
switch careers, interviewers are going to understand that getting a job in
banking is more difficult and that you may need to cast a wider net.  In these
instances, I think that as long as you state that banking is your top choice,
it’s okay to mention that you are interviewing with other institutions,
provided that they are in finance and require similar skill-sets (e.g. equity
research, corporate banking, etc.)  Whatever you do, don’t state (even if it is
true) that you are looking at banking, consulting, hedge funds, private equity
and also considering going to cooking school.  You’ll come across as
unfocused and not serious about being an investment banker.

Do you have any questions for me?

At the end of almost every interview, you will be asked if you have any
questions.  This is your opportunity to learn more about the job and the
firm.  By asking good questions, it is also a chance for you to open up the
interview into more of a conversation.

However, even if you have little interest in the job, or if you’ve already had
all of your questions answered by the other 8 people with whom you
interviewed that day, you should always be prepared with 3-4 questions that
you can ask an interviewer.  Here’s a few examples:

- How long have you been with the bank and how has your experience been?
- What do you like best about working here.  Worst?- How do you compare
working here with other banks at which you have worked?- How is the
dealflow?- On what types of deals are you currently working?- What kind of
responsibility does the typical Analyst/Associate receive?- Can you tell me
about your training program?- How do Analysts/Associates get staffed?

What NOT to ask…

How much money did you make last year?/How much money will I
make?/How were bonuses last year?/How much vacation will I get?…No
explanation needed…I hope.

What is the lifestyle like?/How many hours will I be expected to work?/Is

there face time at this bank?Any questions regarding lifestyle and hours, risk
giving the interviewer the impression that you are not willing to work hard. 
Now, if you are interviewing at a boutique and the interviewer has already
talked about how good the lifestyle is here, then it may be okay to ask these
things.  But if you are interviewing at a bulge bracket bank or the like, don’t
ask about lifestyle.

II. Technical Questions

A) Accounting Questions

How does ??? impact the three financial statements?

Varieties of this question are some of the most common technical question
asked in interviews today.  This type of question attempts to test your
understanding of how the three financial statements (income statement,
balance sheet, cash flow statement) fit together.  The most common variation
of this question is how does $10 of depreciation affect the three financial
statements (answered below).  I’ve posted a few additional examples as well.

To answer this question, take the 3 statements one at a time. My advice is to

start with the income statement.  Remember to tax-affect any change in
revenue or costs (usually you will be told to assume a tax rate of 40%). 
Work your way down to net income.  Next, tackle the cash flow
statement.  The first line of the cash flow statement is net income so start
with that and work your way down to net change in cash.  Last, take the
balance sheet.  The first line of the balance sheet is cash so again, start with
that.  The balance sheet must balance in order for your answer to be correct,
which is why I recommend doing the balance sheet last.  Remember the
basic balance sheet equation:  Assets = Liabilities + Shareholders’ Equity.

Don’t get too stressed when asked a question like this.  Just take it slowly,
one statement at a time.

Category: Accounting and Financial Statements | One comment -

(Comments are closed)
If a company incurs $10 (pretax) of depreciation expense, how does that
affect the three financial statements?
The most common version of this type of question.  Note that the amount of
depreciation may be a number other than $10.  To answer this question, take
the three statements one at a time.

First, the income statement:  depreciation is an expense so operating income

(EBIT) declines by $10.  Assuming a tax rate of 40%, net income declines
by $6.  Second, the cash flow statement:  We know from the cash flow
statement that cash increased $4.  The $6 reduction of net income caused
retained earnings to decrease by $6.  Note that the balance sheet is now
balanced.  Assets decreased $6 (PP&E -10 and Cash +4) and shareholder’s
equity decreased $6.

You may get the follow-up question:  If depreciation is non-cash, explain

how this transaction caused cash to increase $4.  The answer is that
because of the depreciation expense, the company had to pay the
government $4 less in taxes so it increased its cash position by $4 from what
it would have been without the depreciation expense.

A company makes a $100 cash purchase of equipment on Dec. 31. How

does this impact the three statements this year and next year?
First Year:  Let’s assume that the company’s fiscal year ends Dec. 31.  The
relevance of the purchase date is that we will assume no depreciation the
first year.  Income Statement:  A purchase of equipment is considered a
capital expenditure which does not impact earnings.  Further, since we are
assuming no depreciation, there is no impact to net income, thus no impact
to the income statement.  Cash Flow Statement:  No change to net income so
no change to cash flow from operations.  However we’ve got a $100
increase in capex so there is a $100 use of cash in cash flow from investing
activities.  No change in cash flow from financing (since this is a cash
purchase) so the net effect is a use of cash of $100.  Balance Sheet:  Cash
(asset) down $100 and PP&E (asset) up $100 so no net change to the left
side of the balance sheet and no change to the right side.  We are balanced.

Second Year:  Here let’s assume straightline depreciation over 5 years and a

40% tax rate.  Income Statement:  Just like the previous question:  $20 of
depreciation, which results in a $12 reduction to net income.  Cash Flow
Statement:  Net income down $12 and depreciation up $20.  No
change to cash flow from investing or financing activities.  Net effect is cash
up $8.  Balance Sheet:  Cash (asset) up $8 and PP&E (asset) down $20
so left side of balance sheet doen $12.  Retained earnings (shareholders’
equity) down $12 and again, we are balanced.

Same question as the previous but the company finances the purchase of
equipment by issuing debt rather than paying cash.
First Year:  Income Statement:  No depreciation and no interest expense so
no change.  Cash Flow Statement:  No change to net income so no change to
cash flow from operations.  Just like the previous question, we’ve got a $100
increase in capex so there is a $100 use of cash in cash flow from investing
activities.  Now, however, in our cash flows from financing section, we’ve
got an increase in debt of $100 (source of cash).  Net effect is no change to
cash.  Balance Sheet:  No change to cash (asset), PP&E (asset) up $100 and
debt (liability) up $100 so we balance.

Second Year:  Same depreciation and tax assumptions as previously.  Let’s

also assume a 10% interest rate on the debt and no debt amortization. 
Income Statement:  Just like the previous question:  $20 of depreciation but
now we also have $10 of interest expense.  Net result is a $18 reduction to
net income ($30 x (1 – 40%)).  Cash Flow Statement:  Net income down $18
and depreciation up $20.  No change to cash flow from investing or
financing activities (if we assumed some debt amortization, we would have a
use of cash in financing activities).  Net effect is cash up $2.  Balance Sheet: 
Cash (asset) up $2 and PP&E (asset) down $20 so left side of balance sheet
down $18.  Retained earnings (shareholders’ equity) down $18 and voila, we
are balanced.

Continuing with the last question, on Jan. 1 of Year 3 the equipment

breaks and is deemed worthless. The bank calls in the loan. What
happens in Year 3?
Now the company must writedown the value of the equipment down to $0. 
At the beginning of Year 3, the equipment is on the books at $80 after one
year’s depreciation.  Further, the company must pay back the entire loan. 
Income statement: The $80 writedown causes net income to decline $48. 
There is no further depreciation expense and no interest expense.   Cash
Flow Statement: Net income down $48 but the writedown is non-cash so add
$80.  Cash flow from financing decreases $100 when we pay back the loan. 
Net cash is down $68.  Balance Sheet:  Cash (asset) down $68, PP&E (asset)
down $80, Debt (liability) down $100 and Retained Earnings (shareholders’
equity) down $48.  Left side of the balance sheet is down $148 and right side
is down $148 and we’re good!

B) Valuation

Of the three main valuation methodologies, which ones are likely to

result in higher/lower value?
Firstly, the Precedent Transactions methodology is likely to give a higher
valuation than the Comparable Company methodology.  This is because
when companies are purchased, the target’s shareholders are typically paid a
price that is higher than the target’s current stock price.  Technically
speaking, the purchase price includes a “control premium.” Valuing
companies based on M&A transactions (a control based valuation
methodology) will include this control premium and therefore likely result in
a higher valuation than a public market valuation (minority interest based
valuation methodology).
The Discounted Cash Flow (DCF) analysis will also likely result in a higher
valuation than the Comparable Company analysis because DCF is also a
control based methodology and because most projections tend to be pretty
optimistic.  Whether DCF will be higher than Precedent Transactions is
debatable but is fair to say that DCF valuations tend to be more variable
because the DCF is so sensitive to a multitude of inputs or assumptions.

How do you use the three main valuation methodologies to conclude

value?
The best way to answer this question is to say that you calculate a valuation
range for each of the three methodologies and then “triangulate” the three
ranges to conclude a valuation range for the company or asset being valued. 
You may also put more weight on one or two of the methodologies if you
think that they give you a more accurate valuation.  For example, if you have
good comps and good precedent transactions but have little faith in your
projections, then you will likely rely more on the Comparable Company and
Precedent Transaction analyses than on your DCF.

What are some other possible valuation methodologies in addition to the

main three?
Other valuation methodologies include leverage buyout (LBO) analysis,
replacement value and liquidation value.

What are some common valuation metrics?

Probably the most common valuation metric used in banking is Enterprise
Value (EV)/EBITDA.  Some others include EV/Sales, EV/EBIT, Price to
Earnings (P/E) and Price to Book Value (P/BV).

Why can’t you use EV/Earnings or Price/EBITDA as valuation metrics?

Enterprise Value (EV) equals the value of the operations of the company
attributable to all providers of capital.  That is to say, because EV
incorporates all of both debt and equity, it is NOT dependant on the choice
of capital structure (i.e. the percentage of debt and equity).  If we use EV in
the numerator of our valuation metric, to be consistent (apples to apples) we
must use an operating or capital structure neutral (unlevered) metric in the
denominator, such as Sales, EBIT or EBITDA.  These such metrics are also
not dependant on capital structure because they do not include interest
expense.  Operating metrics such as earnings do include interest and so are
considered leveraged or capital structure dependant metrics.  Therefore
EV/Earnings is an apples to oranges comparison and is considered
inconsistent.  Similarly Price/EBITDA is inconsistent because Price (or
equity value) is dependant on capital structure (levered) while EBITDA is
unlevered.  Again, apples to oranges.  Price/Earnings is fine (apples to
apples) because they are both levered.

What is the formula for Enterprise Value?

The formula for enterprise value is:  market value of equity (MVE) + debt +
preferred stock + minority interest – cash.

C) DCF Analysis
Walk me through a Discounted Cash Flow (“DCF”) analysis…
In order to do a DCF analysis, first we need to project free cash flow for a
period of time (say, five years).  Free cash flow equals EBIT less taxes plus
D&A less capital expenditures less the change in working capital.  Note that
this measure of free cash flow is unlevered or debt-free.  This is because it
does not include interest and so is independent of debt and capital structure.

Next we need a way to predict the value of the company/assets for the years
beyond the projection period (5 years).  This is known as the Terminal
Value.  We can use one of two methods for calculating terminal value, either
the Gordon Growth (also called Perpetuity Growth) method or the Terminal
Multiple method.  To use the Gordon Growth method, we must choose an
appropriate rate by which the company can grow forever.  This growth rate
should be modest, for example, average long-term expected GDP growth or
inflation.  To calculate terminal value we multiply the last year’s free cash
flow (year 5) by 1 plus the chosen growth rate, and then divide by the
discount rate less growth rate.

The second method, the Terminal Multiple method, is the one that is more
often used in banking.  Here we take an operating metric for the last
projected period (year 5) and multiply it by an appropriate valuation
multiple.  This most common metric to use is EBITDA.  We typically select
the appropriate EBITDA multiple by taking what we concluded for
our comparable company analysis on a last twelve months (LTM) basis.

Now that we have our projections of free cash flows and terminal value, we
need to “present value” these at the appropriate discount rate, also known as
weighted average cost of capital (WACC).  For discussion of calculating the
WACC, please read the next topic.   Finally, summing up the present value
of the projected cash flows and the present value of the terminal value gives
us the DCF value.  Note that because we used unlevered cash flows and
WACC as our discount rate, the DCF value is a representation of Enterprise
Value, not Equity Value.

What is WACC and how do you calculate it?

The WACC (Weighted Average Cost of Capital) is the discount rate used in
a Discounted Cash Flow (DCF) analysis to present value projected free cash
flows and terminal value.  Conceptually, the WACC represents the blended
opportunity cost to lenders and investors of a company or set of assets with a
similar risk profile.  The WACC reflects the cost of each type of capital
(debt (“D”), equity (“E”) and preferred stock (“P”)) weighted by the
respective percentage of each type of capital assumed for the company’s
optimal capital structure.  Specifically the formula for WACC is:  Cost of
Equity (Ke) times % of Equity (E/E+D+P) + Cost of Debt (Kd) times % of
Debt (D/E+D+P) times (1-tax rate) + Cost of Preferred (Kp) times % of
Preferred (P/E+D+P).

To estimate the cost of equity, we will typically use the Capital Asset
Pricing Model (“CAPM”) (see the following topic).  To estimate the cost of
debt, we can analyze the interest rates/yields on debt issued by similar
companies.  Similar to the cost of debt, estimating the cost of preferred
requires us to analyze the dividend yields on preferred stock issued by
similar companies.

How do you calculate the cost of equity?

To calculate a company’s cost of equity, we typically use the Capital Asset
Pricing Model (CAPM).  The CAPM formula states the cost of equity equals
the risk free rate plus the multiplication of Beta times the equity risk
premium.  The risk free rate (for a U.S. company) is generally considered to
be the yield on a 10 or 20 year U.S. Treasury Bond.  Beta (See the following
question on Beta) should be levered and represents the riskiness
(equivalently, expected return) of the company’s equity relative to the
overall equity markets.  The equity risk premium is the amount that stocks
are expected to outperform the risk free rate over the long-term.  Prior to the
credit crises, most banks tend to use an equity risk premium of between 4%
and 5%.  However, today is assumed that the equity risk premium is higher.

What is Beta?
Beta is a measure of the riskiness of a stock relative to the broader market
(for broader market, think S&P500, Wilshire 5000, etc).  By definition the
“market” has a Beta of one (1.0).  So a stock with a Beta above 1 is
perceived to be more risky than the market and a stock with a Beta of less
than 1 is perceived to be less risky.  For example, if the market is expected
to outperform the risk-free rate by 10%, a stock with a Beta of 1.1 will be
expected to outperform by 11% while a stock with a Beta of 0.9 will be
expected to outperform by 9%.  A stock with a Beta of -1.0 would be
expected to underperform the risk-free rate by 10%.  Beta is used in the
capital asset pricing model (CAPM) for the purpose of calculating a
company’s cost of equity.  For those few of you that remember your
statistics and like precision, Beta is calculated as the covariance
between a stock’s return and the market return divided by the variance of the
market return.

When using the CAPM for purposes of calculating WACC, why do you
have to unlever and then relever Beta?
In order to use the CAPM to calculate our cost of equity, we need to
estimate the appropriate Beta.  We typically get the appropriate Beta from
our comparable companies (often the mean or median Beta).  However
before we can use this “industry” Beta we must first unlever the Beta of each
of our comps.  The Beta that we will get (say from Bloomberg or Barra) will
be a levered Beta.

Recall what Beta is:  in simple terms, how risky a stock is relative to the
market.  Other things being equal, stocks of companies that have debt are
somewhat more risky that stocks of companies without debt (or that have
less debt).  This is because even a small amount of debt increases the risk of
bankruptcy and also because any obligation to pay interest represents funds
that cannot be used for running and growing the business.  In other words,
debt reduces the flexibility of management which makes owning equity in
the company more risky.

Now, in order to use the Betas of the comps to conclude an appropriate Beta
for the company we are valuing, we must first strip out the impact of debt
from the comps’ Betas.  This is known as unlevering Beta.  After unlevering
the Betas, we can now use the appropriate “industry” Beta (e.g. the mean of
the comps’ unlevered Betas) and relever it for the appropriate capital
structure of the company being valued.  After relevering, we can use the
levered Beta in the CAPM formula to calculate cost of equity.

What are the formulas for unlevering and levering Beta?

Unlevered Beta = Levered Beta / (1 + ((1 – Tax Rate) x (Debt/Equity)))

Levered Beta = Unlevered Beta x (1 + ((1 – Tax Rate) x (Debt/Equity)))

Which is less expensive capital, debt or equity?
Debt is less expensive for two main reasons.  First, interest on debt is tax
deductible (i.e. the tax shield).  Second, debt is senior to equity in a firm’s
capital structure.  That is, in a liquidation or bankruptcy, the debt holders get
paid first before the equity holders receive anything.  Note, debt being less
expensive capital is the equivalent to saying the cost of debt is lower than
the cost of equity.

D) LBO Analysis

Walk me through an LBO analysis…

First, we need to make some transaction assumptions.  What is the purchase
price and how will the deal be financed?  With this information, we can
create a table of Sources and Uses (where Sources equals Uses).  Uses
reflects the amount of money required to effectuate the transaction,
including the equity purchase price, any existing debt being refinanced and
any transaction fees.  The Sources tells us from where the money is coming,
including the new debt, any existing cash that will be used, as well as the
equity contributed by the private equity firm.  Typically, the amount of debt
is assumed based on the state of the capital markets and other factors, and
the amount of equity is the difference between the Uses (total funding
required) and all of the other sources of funding.

The next step is to change the existing balance sheet of the company to
reflect the transaction and the new capital structure.  This is known
as constructing the “proforma” balance sheet.  In addition to the changes to
debt and equity, intangible assets such as goodwill and capitalized financing
fees will likely be created.

The third, and typically most substantial step is to create an integrated cash
flow model for the company.  In other words, to project the company’s
income statement, balance sheet and cash flow statement for a period of time
(say, five years).  The balance sheet must be projected based on the newly
created proforma balance sheet.  Debt and interest must be projected based
on the post-transaction debt.

Once the functioning model is created, we can make assumptions about

the private equity firm’s exit from its investment.  For example, a typical
assumption is that the company is sold after five years at the same implied
EBITDA multiple at which the company was purchased.  Projecting a sale
value for the company allows us to also calculate the value of the private
equity firm’s equity stake which we can then use to analyze its internal rate
of return (IRR).  Absent dividends or additional equity infusions, the IRR
equals the average annual compounded rate at which the PE firm’s original
equity investment grows (to its value at the exit).

While the private equity firm’s IRR is usually the most important piece of
information that comes out of an LBO analysis, the analysis also has other
uses.  By assuming the PE firm’s required IRR (amongst other things), we
can back into a purchase price for the company, thus using the analysis for
valuation purposes.  In addition, we can utilize the LBO model to analyze
the trend of credit statistics (such as the leverage ratio and interest coverage
ratio) which is especially important from a lender’s perspective.

Why do private equity firms use leverage when buying a company?

By using significant amounts of leverage (debt) to help finance the purchase
price, the private equity firm reduces the amount of money (the equity) that
it must contribute to the deal.  Reducing the amount of equity contributed
will result in a substantial increase to the private equity firm’s rate of
return upon exiting the investment (e.g. selling the company five years
later).

Let’s say you run an LBO analysis and the private equity firm’s return
is too low. What drivers to the model will increase the return?
Some of the key ways to increase the PE firm’s return (in theory, at least)
include:

• - reduce the purchase price that the PE firm has to pay for the company
• - increase the amount of leverage (debt) in the deal
• - increase the price for which the company sells when the PE firm exits its
investment (i.e. increase the assumed exit multiple)
• - increase the company’s growth rate in order to raise operating
income/cash flow/EBITDA in the projectionsdecrease the company’s
costs in order to raise operating income/cash flow/EBITDA in the
projections
What are some characteristics of a company that is a good LBO
candidate?
Notwithstanding the recent LBO boom where nearly all companies were
considered to be possible LBO candidates, characteristics of a good LBO
target include steady cash flows, limited business risk, limited need for
ongoing investment (e.g. capital expenditures or working capital), strong
management, opportunity for cost reductions and a high asset base (to use as
debt collateral).  The most important trait is steady cash flows, as the
company must have the ability to generate the cash flow required to support
relatively high interest expense.

E) Enterprise Value and Equity Value

What is the difference between enterprise value and equity value?

Enterprise Value represents the value of the operations of a company
attributable to all providers of capital.  Equity Value is one of the
components of Enterprise Value and represents only the proportion of value
attributable to shareholders.

How do you calculate the market value of equity?

A company’s market value of equity (MVE) equals its share price multiplied
by the number of fully diluted shares outstanding.

What is the difference between basic shares and fully diluted shares?
Basic shares represent the number of common shares that are outstanding
today (or as of the reporting date).  Fully diluted shares equals basic shares
plus the potentially dilutive effect from any outstanding stock options,
warrants, convertible preferred stock or convertible debt.  In calculating a
company’s market value of equity (MVE) we always want to use diluted
shares.  Implicitly the market also uses diluted shares to value a company’s
stock.

How do you calculate fully diluted shares?

To calculate fully diluted shares, we need to add the basic number of shares
(found on the cover of a company’s most recent 10Q or 10K) and the
dilutive effect of employee stock options.  To calculate the dilutive effect of
options we typically use the Treasury Stock Method.  The options
information can be found in the company’s latest 10K.  Note that if the
company has other potentially dilutive securities (e.g. convertible preferred
stock or convertible debt) we may need to account for those as well in our
fully diluted share count.

How do we use the Treasury Stock Method to calculate diluted shares?

To use the Treasury Stock Method, we first need a tally of the company’s
issued stock options and weighted average exercise prices.  We get this
information from the company’s most recent 10K.  If our calculation will be
used for a control based valuation methodology (i.e. precedent transactions)
or M&A analysis, we will use all of the options outstanding.  If our
calculation is for a minority interest based valuation methodology (i.e.
comparable companies) we will use only options exercisable.  Note that
options exercisable are options that have vested while options outstanding
takes into account both options that have vested and that have not yet vested.

Once we have this option information, we subtract the exercise price of the
options from the current share price (or per share purchase price for an
M&A analysis), divide by the share price (or purchase price) and multiply
by the number of options outstanding.  We repeat this calculation for each
subset of options reported in the 10K (usually companies will report several
line items of options categorized by exercise price).  Aggregating the
calculations gives us the amount of diluted shares.  If the exercise price of an
option is greater than the share price (or purchase price) then the options are
out-of-the-money and have no dilutive effect.

The concept of the treasury stock method is that when employees exercise
options, the company has to issue the appropriate number of new shares but
also receives the exercise price of the options in cash.  Implicitly, the
company can “use” this cash to offset the cost of issuing new shares.  This is
why the diluted effect of exercising one option is not one full share of
dilution, but a fraction of a share equal to what the company does NOT
receive in cash divided by the share price.

Why do you subtract cash in the enterprise value formula?

Cash gets subtracted when calculating Enterprise Value because (1) cash is
considered a non-operating asset AND (2) cash is already implicitly
accounted for within equity value.  Note that when we subtract cash, to be
precise, we should say excess cash.  However, we will typically make the
assumption that a company’s cash balance (including cash equivalents such
as marketable securities or short-term investments) equals excess cash.

What is Minority Interest and why do we add it in the Enterprise Value

formula?
When a company owns more than 50% of another company,
U.S. accounting rules state that the parent company has to consolidate its
books.  In other words, the parent company reflects 100% of the assets and
liabilities and 100% of financial performance (revenue, costs, profits, etc.) of
the majority-owned subsidiary (the “sub”) on its own financial statements. 
But since the parent company does not 100% of the sub, the parent company
will have a line item called minority interest on its income statement
reflecting the portion of the sub’s net income that the parent is not entitled to
(the percentage that it does not own).  The parent company’s balance sheet
will also contain a line item called minority interest which reflects the
percentage of the sub’s book value of equity that the parent does NOT own. 
It is the balance sheet minority interest figure that we add in the Enterprise
Value formula.

Now, keep in mind that the main use for Enterprise Value is to create
valuation ratios/metrics (e.g. EV/Sales, EV/EBITDA, etc.)  When we take,
say, sales or EBITDA from the parent company’s financial statements, these
figures due to the accounting consolidation, will contain 100% of the sub’s
sales or EBITDA, even though the parent does not own 100%.  In order to
counteract this, we must add to Enterprise Value, the value of the sub that
the parent company does not own (the minority interest).  By doing this,
both the numerator and denominator of our valuation metric account for
100% of the sub, and we have a consistent (apples to apples) metric.

One might ask, instead of adding minority interest to Enterprise Value, why
don’t we just subtract the portion of sales or EBITDA that the parent does
NOT own.  In theory, this would indeed work and may in fact be more
accurate.  However, typically we do not have enough information about the
sub to do such an adjustment (minority owned subs are rarely, if ever, public
companies).  Moreover, even if we had the financial information of the sub,
this method is clearly more time consuming.

E) M&A
Walk me through an accretion/dilution analysis…
The purpose of an accretion/dilution analysis (sometimes also referred to as
a quick-and-dirty merger analysis) is to project the impact of an acquisition
to the acquiror’s Earnings Per Share (EPS) and compare how the new EPS
(“proforma EPS”) compares to what the company’s EPS would have been
had it not executed the transaction.

In order to do the accretion/dilution analysis, we need to project the

combined company’s net income (“proforma net income”) and the combined
company’s new share count.  The proforma net income will be the sum of
the buyer’s and target’s projected net income plus/minus certain transaction
adjustments.  Such adjustments to proforma net income (on a post-tax basis)
include synergies (positive or negative), increased interest expense (if debt is
used to finance the purchase), decreased interest income (if cash is used to
finance the purchase) and any new intangible asset amortization resulting
from the transaction.

The proforma share count reflects the acquiror’s share count plus the number
of shares to be created and used to finance the purchase (in a stock deal). 
Dividing proforma net income by proforma shares gives us proforma EPS
which we can then compare to the acquiror’s original EPS to see if the
transaction results in an increase to EPS (accretion) or a decline in EPS
(dilution).  Note also that we typically will perform this analysis using 1-
year and 2-year projected net income and also sometimes last twelve months
(LTM) proforma net income.

What factors can lead to the dilution of EPS in an acquisition?

A number of factors can cause an acquisition to be dilutive to the acquiror’s
earnings per share (EPS), including: (1) the target has negative net income,
(2) the target’s Price/Earnings ratio is greater than the acquiror’s, (3) the
transaction creates a significant amount of intangible assets that must be
amortized going forward, (4) increased interest expense due to new debt
used to finance the transaction, (5) decreased interest income due to less
cash on the balance sheet if cash is used to finance the transaction and (6)
low or negative synergies.

If a company with a low P/E acquires a company with a high P/E in an

all stock deal, will the deal likely be accretive or dilutive?
Other things being equal, if the Price to Earnings ratio (P/E) of
the acquiring company is lower than the P/E of the target, then the deal will
be dilutive to the acquiror’s Earnings Per Share (EPS).  This is because the
acquiror has to pay more for each dollar of earnings than the market values
its own earnings.  Hence, the acquiror will have to issue proportionally more
shares in the transaction.  Mechanically, proforma earnings, which equals
the acquiror’s earnings plus the target’s earnings (the numerator in EPS) will
increase less than the proforma share count (the denominator), causing EPS
to decline.

What is goodwill and how is it calculated?

Goodwill, a type of intangible asset, is created in an acquisition and reflects
the value (from an accounting standpoint) of a company that is not attributed
to its other assets and liabilities.  Goodwill is calculated by subtracting the
target’s book value (written up to fair market value) from the equity
purchase price paid for the company.  This equation is sometimes referred to
a s the “excess purchase price.”  Accounting rules state that goodwill no
longer should be amortized each period, but must be tested once per
year for impairment.  Absent impairment, goodwill can remain on a
company’s balance sheet indefinitely.

Why might one company want to acquire another company?

There are a variety of reasons why companies do
acquisitions.  Some common reasons include:

• - The Buyer views the Target as undervalued.

• - The Buyer’s own organic growth has slowed or stalled and needs to grow
in other ways (via acquiring other companies) in order to satisfy the
growth expectations of Wall Street.
• - The Buyer expects the deal to result in significant synergies (see the next
post for a discussion of synergies).
• - The CEO of the Buyer wants to be CEO of a larger company, either
because of ego, legacy or because he/she will get paid more.

Explain the concept of synergies and provide some examples.

In simple terms, synergy occurs when 2 + 2 = 5.  That is, when the sum of
the value of the Buyer and the Target as a combined company is greater than
the two companies valued apart.  Most mergers and large acquisitions are
justified by the amount of projected synergies.  There are two categories of
synergies:  cost synergies and revenue synergies.  Cost synergies refer to the
ability to cut costs of the combined companies due to the consolidation of
operations.  For example, closing one corporate headquarters, laying off one
set of management, shutting redundant stores, etc.  Revenue synergies refer
to the ability to sell more products/services or raise prices due to the merger. 
For example, increasing sales due to cross-marketing, co-branding, etc.  The
concept of economies of scale can apply to both cost and revenue synergies.

In practice, synergies are “easier said than done.”  While cost synergies are
difficult to achieve, revenue synergies are even harder.  The implication is
that many mergers fail to live up to expectations and wind up destroying
shareholder value rather than create it.  Of course, this last fact never finds
its way into a banker’s M&A pitch

F) Markets Investing
Are markets efficient?
Let’s start with an easy one, albeit important one, albeit one that most
people, academics included, don’t really understand.   And the answer is:  it
depends on the market – but in most cases, for all practical purposes the
answer is yes.  But before we can really answer this question, we need to
define market efficiency very clearly (and very simply).  Forget what you’ve
learned about weak forms and strong forms and the other stuff coming out of
academia.

An efficient market is a market where all publicly available information is

priced in.    What is public information?  Basically, any information that
affects the price of that asset, such as information reported by the company,
by its competitors, suppliers and vendors, macroeconomic data, etc.

So which markets are efficient and which less so?  For the most part, the
larger and more liquid the market, the more efficient.  Large cap U.S. stocks,
U.S. treasuries, currency markets?  All extremely efficient.  Small to mid-
cap U.S. stocks?  Still pretty efficient but certainly less so than large caps.  
Microcap stocks and emerging market stocks – less efficient still.

What does it mean for a market to be efficient?

Essentially it means you can’t make money, without one of the following (1)
luck or (2) non-public information.  Now, to be precise, the phrase “you
can’t make any money” really means, “you will not consistently achieve
risk-adjusted above market returns.”  And by “you” I do mean YOU,
whether you’re a Harvard undergrad day-trading in your dorm, a retiree with
a 401K, or  you’re running a $10 billion mutual fund or hedge fund.

So how do you make money in the “markets?”

Since luck is pretty hard to control, let’s talk about the second factor: 
having non-public information.  Now, of course there are two types of non-
public information.  The legal type and the illegal type.  Here at
IBankingFAQ, we recommend the legal type, at least in the United States
(we give no such recommendation for those investing outside the U.S. ) 
Most of you probably know what the illegal type is – usually called “insider
information.”  An example of this would be investing in an airline of which
your Dad has influence over union decisions.

The legal type would be any information not known by the broader investing
community that has not been obtained illegally (i.e. in violation of SEC or
other regulatory body regulations).  For example, hedge funds that cover
retailers might send consultants to a retail store to count cars in the parking
lot or peak into stock rooms to count inventory levels, given them non-
public insight into the financial results of the retailer.   Or perhaps a doctor,
due to his or her own specialty has indirect insight into the likely success or
failure of a new drug in clinical trials.  Or maybe a mutual fund manager has
the ability to meet directly with a management team.  Even if no non-public
information is disclosed by the CEO during that meeting, the fund manager
might have insight into the quality of the CEO that other market participants,
who do not have the ability to meet management, cannot have.  Keep in
mind that often there is a very fine line between legally obtained non-public
information and illegal insider information.

So how does one go about legally obtaining non-public information?  Well,

aside from the examples I’ve given above, the answer is that it is usually
extraordinarily difficult as an individual investor and still extremely difficult
as an institutional investor.   The short answer is if you’re going to try to
make money in financial markets,  concentrate on less efficient markets such
as small cap stocks or emerging markets but ONLY if you have the ability to
uncover non-public information.

The even shorter answer is, its nearly impossible for an individual investor
(or institutional investor such as a hedge fund) to outperform the market so
don’t even try.

If you say markets are efficient, then explain the dot-com bubble or the
real estate bubble.
Ah ha!  You think you’ve got me, don’t you?

Recall the definition of an efficient market:  that all public information is

priced in.  I never said that prices were fundamentally correct (more on this
in the next question).  I merely said to be efficient prices must reflect all
publicly available information.  If the consensus amongst the public (i.e.
market participants)  is that we’re in a new era of phenomenal growth to
which the world has never seen before, then that public sentiment (or more
precisely, that economic outlook or forecast) will be priced into stocks (or
other financial assets).  That overly optimistic sentiment may be ultimately
shown to be foolish or short-sighted, but it does not mean that markets are
inefficient, or even wrong.

Aren’t you saying that there is no such thing as a bubble?

No.  Prices of financial assets can certainly rise to unsustainable levels due
to overly optimistic forecasts.  And this is actually pretty easy to spot, at
least near its peak.  You may recall that plenty of market commentators and
academics spoke of an Internet bubble in the late ’90s and a real estate
bubble in the last few years.  What I am saying is that just because asset
prices may vary greatly over time (say NASDAQ at over 5000 in March
2000 and at about 1100 two and a half years later) doesn’t mean that markets
are inefficient.  It just means that public information (i.e. market sentiment
and forecasts) changed.

I still don’t get it. How can fundamental value change in such a short
period of time?
Now you’re thinking.  Fundamental value doesn’t change because there is
no such thing as fundamental value.  Let me repeat that again:  there is no
such thing as fundamental value.  This is perhaps the most important myth
of finance (and economics).  There is only relative value.  Those of you that
are on this site doing  investment banking interview prep know that the way
you value a company is by comparing its value to other similar companies
(even our so called “intrinsic value” DCF analysis uses comparisons to come
up with forecasts, terminal values and WACC).  So, if Amazon in 1999
trades at a 100x P/E ratio than why shouldn’t Ebay or Pets.com?  Similarly,
if my neighbor’s ocean front Miami beach condo sells for $1 million
shouldn’t my identical one also be valued at $1 million?  That there is no
such thing as fundamental value is true for not only financial assets but
applies to all assets.

Even if markets are efficient then surely a boom or subsequent bust

proves that market participants are irrational, right?
Wrong.  Not just wrong, but WRONG.  This is one question that everyone
and I mean everyone gets wrong.  People are rational.  Period.  Full Stop. 
(No, I’m not Milton Friedman writing from the grave).

How can you say that people are rational given all of the research that
seems to show otherwise in addition to all of the booms and busts
throughout history?
Okay, this is really important.  To really understand this point, let’s first
understand how economists usually define rationality.  An economic actor
(that is to say, a person)  is rational if he or she always makes decisions
which will maximize his or her economic well being.  Now, there is an
enormous body of research in psychology and behavioral economics (the
same field by the way – just that the economics know how to use statistics)
that shows otherwise.  This we do not dispute in the least.

What we dispute is the above definition of rationality.  It is wrong in three

ways.  The most obvious way it is wrong is that we don’t maximize our
current economic well being but the present value of our well being.  Now, I
would guess that almost all economists would probably agree with this
modified definition.  But it is a very important distinction because people
have very different discount rates.  That is to say, some people place much
more value on well being today versus well being in the future.  To place
more value on well being today is not irrational if one’s discount rate at the
time is higher.

The second error in the definition of rationality is that people don’t seek to
maximize their economic being (that is to say, their wealth or income) but
their overall well being or their “utility”.  (I have a lot more to say about the
definition utility but for now leave it as one’s overall well-being).  Now
again, most economics would agree with this modification to the definition
but alas, fail to internalize the distinction.  Understanding that many
decisions (even investing ones) are affected by things are than income or
wealth goes far to explain many of the experiments that claim to prove that
people are irrational.  For example, many studies have shown that individual
investors trade too much even though they know that trading costs hurt their
overall investment performance.  Therefore, they are irrational, right?  Not
necessarily.  Most individuals who trade in and out of stocks get other utility
out of their actions.  That is to say, trading is fun, not unlike, say, going to
Las Vegas.  In other words, the entertainment value of trading adds more to
their utility than the lost money due to trading costs subtracts.  There is
nothing irrational about that.

The third and final error is probably the most important one and also the
least understood.  Many experiments have shown that when faced with a
probability based decision many people make the wrong choice (that is one
that results in lower expected value) or given two sets of decisions, make
inconsistent choices.  These types of experiments are used to demonstrate
the irrationality of human beings.  But this is wrong.  What they demonstrate
mostly is that humans are bad at probabilities (they demonstrate other things
as well – for example that most of us would rather not lose money than gain
money).  Perhaps we’re all dumb, perhaps we all slept through statistics
class in college or perhaps our incentives are messed up.  That we don’t fully
understand the question or that we didn’t bother (or don’t know how) to do
the expected value arithmetic does not demonstrate irrationality.  So the
third distinction that we need to make to our definition of rationality is that
we make decisions to maximize the present value of our utility based on the
decision maker’s understanding of the decision and NOT the experimenter’s
understanding of the decision.

Assuming you’re still reading this and haven’t fallen asleep, you might be
wondering so what?  Who cares if people are rational or  not?  Let’s talk
about that next.

Who cares if investors are rational or irrational?

To some extent this is really an academic argument.  Why does it matter if
investors make rational and stupid decisions (as I say) or irrational ones (as
everyone else says).  I do think knowledge for knowledge sake is cool and to
better understand how people make decisions is cool too.  However I also
think there is something very important about the distinction as it relates to
policy.

Given today’s economic situation, the irrationality of investors and

economic actors is being used to justify hugely significant policy decisions. 
Instead we should be focusing on, for example, the horribly wrong incentive
structures throughout the finance system that led to (rational) decision
making which in turn led to the our current economic woes (much more to
come about this under Current Economic Situation category).   We also
should be focusing on how to educate people to make smarter decisions (i.e.
to understand economic and finance decisions).

It is also important to understand the fallacy of irrationality because it is

being used as key evidence of the inherent failure or instability of a free
market system.   This couldn’t be further from the truth, as we will also
discuss in other posts.

If people are indeed rational, as you say, then how can bubbles arise
and persist for so long?

Is investing in stocks really investing?

No.  Buying stocks is speculating.  Even if you’re buying value stocks. 
Even if you’re planning to hold stocks for the long-term (whatever that
means).  I wish more people understood this.  Anytime you spend money on
the hope and prayer that the thing you bought appreciates in value, you are
speculating, not investing.  Here’s another way to think about it.  If you have
significant control over your spent money (say, starting a business or
building a new factory) then you’re investing.  If you don’t then you’re
speculating.

Oh, and one last thing:  speculating is just a more acceptable synonym for
gambling.

Category: Markets and Investing | Leave a comment

Does fundamental analysis work?
As we alluded to when we were discussing the efficiency of markets,
fundamental analysis works if and only if you can discover important
enough non-public information AND that non-public information will
become public within a reasonable time frame.  It is not enough to discover
the information because if other market participants don’t learn about it
(there’s no “catalyst”), prices won’t reflect it and you can’t make money on
it.

Now, one type of non-public information would be to have a different

(better) view on the company’s prospects or on say, macroeconomic
prospects.  Three things make this very difficult in practice.  Firstly, it is
very difficult to be smarter than the market.  Second, even if you are correct,
it often takes much longer to be proven right, hurting your returns (or
worse).  This is analogous to Keyne’s famous statement that the market can
remain irrational far longer than you can be solvent.  I would, of course,
modify this to say that the market can remain stupid far longer than you can
be solvent. Third, since the market tends to lean towards optimism most of
the time, having a contrarian view usually means being short the market. 
Shorting the market brings its own set of risks and is a strategy that is
extraordinarily difficult with which to make money.  You may have noted
that numbers 2 and 3 help illustrate why bubbles can persist for a long time.

Does technical analysis work?

Yes.  No.  Maybe.

I think all three are correct depending on how we define technical analysis. 
Academics have known for about 15 years that stocks with positive
momentum tend to outperform stocks with negative momentum.  Traders
and speculators have probably known this for centuries longer.  If we define
technical analysis as using information contained in historical prices (and
other information such as trading volume) to predict future prices than there
is no question the answer is yes, technical analysis does work.  Most
quantitative trading methods (including high frequency trading) is based on
this sort of analysis.  In fact, I would go as far as to say that much of what
people view as fundamental analysis is actually technical analysis.  I would
argue that much of value investing (e.g. buying stocks with low Price/Book
Value ratios or Price/Earnings ratios is actually a reflection of technical
factors (the stock has gone down in the past) than it is of fundamental factors
such as its book value or earnings.

If, however, we define technical analysis as humans looking at charts

looking for patterns which they then give cool names, I am more than a little
skeptical.  Not because the charts don’t contain good information (they
contain the same information used by the computers discussed above) but
because I am skeptical that humans can consistently and correctly interpret
this information.  I do leave open the possible that certain exceptional
individuals can indeed profit from interpreting such charts.

I’ve stated that technical analysis is essentially just momentum investing (I

use the word investing loosely).  I think its worth mentioning that virtually
all trading is based on momentum investing.  Of course the downside of
momentum (from the trader’s perspective) as a strategy is that it works until
it doesn’t.   Which is to say you’ve got to get out in time (no easy task),
making it a risky strategy.  From the market’s prospective, it is not difficult
to see the relationship between momentum and frothy markets.