What Makes New Constructs' Research Different

Attendees are in listen-only mode. Welcome to this week's webinar. Thanks to everybody for joining us. I'm excited to be with you today. Our focus is going to be on other research firms and how their research compares to ours. I think as we've talked through the offerings that New Constructs provides, In the last few webinars, I think we've done a good job of going into the kind of detail that our research provides and the level of diligence that goes into each and every one of our models. If you have a portfolio in our system, we'll give you ratings very quickly and we will give you the details behind that. And we also, we're quantitatively focused, but we're also sort of very quantitatively I believe strict and disciplined, that we're going to focus on quality of earnings and valuation. And we're going to give you the best sense of what profitability is and how the market's valuation relates to what the profitability has been. When there are big disconnects between what the market expects the company to do compared to what it's done in the past, we'll highlight that, whether it's because market expectations are very low, as they are in this situation. For CA Inc., or in other situations where market expectations can be very high, such as they are for one of my favorite whipping boys is Netflix, right? And what you're seeing here is a decent business, decent quality of earnings, expensive valuation. And then there's going to be detail as to how we have adjusted the income statement and the balance sheet to better reflect the truth about profitability and the truth about valuation. You see here income statement adjustments, balance sheet adjustments over the past 5 years, and then on the valuation side, we're going to show you all these adjustments as well. And so what is it that makes our research unique? In a nutshell, 2 things, and this is our focus on all of our reports and our models. Look, the best quality of earnings work in the business and the best valuation work in the business. If that's what you care about, New Constructs is the best research firm in the world for you. Now, if you care about other things, momentum, technical trading, day trading, we're not going to be as helpful. Now, are we a protective overlay even to those strategies? Yes. I've had clients say, that they are primarily momentum or technically driven. But when it comes to 2 different investment ideas, both of whom have good-looking technicals or good-looking momentum, they'd rather have the one that also has the good fundamental. For me, you know, it's kind of an old-school value investor type. The value investing strategy is the cornerstone of what you want to focus on because it's, it's, it's your risk, it's your risk tolerance. Everything else is just kind of trying to play games. So we're going to talk about multiple different research providers. We're going to look at a sample report from Value Engine, which is a very popular sort of retail-level tool that gives you some kind of very good quick basics. We're going to go through a report from S&P Capital IQ. We're going to look at a report from Zacks, a really short one. We're going to look at something from Morningstar. And we're going to go through each one of these and talk about, you know, how does New Constructs research compare. Let me download one of our reports. Most of you have maybe seen one of these, but we'll show you a quick sample of our report on Netflix. And you're going to see something that focuses on what's unique about New Constructs. I think most of my clients will know from meetings that we've had, our focus when it comes to research is giving you something you can't get anyplace else. I'm not interested in giving you something you can get from Yahoo, right? I'm going to give you something you can't get someplace else for free. Some of our research competitors are really more a little focused on trying to give you You know, a little bit of everything so you can kind of go to one spot and see what's offered. Not us. We're going to give you something really, really good about profitability and valuation. Here you can see is the centerpiece, our rating system. We'll give you a quick summary of what that rating system means, what a dangerous rating means. And then we're going to go into detail into each one of these rating criteria. And I'm going to go through this quickly because I know we're focused on some of the other research firms. But as always, I feel like a good idea to review What makes our research unique? It's going to be the focus on accounting versus economic earnings. All right. How does a company's reported profits compare to the actual underlying economic profits? And you see with Netflix, both are trending up, though accounting earnings are trending up a little faster. Not good. We're going to look at returns. We're going into more detail here in the economic versus reported earnings on this, on the second page. Then look at return on capital versus the cost of capital. We'll look at free cash flow yield over time, price-to-economic book value over time, and we've gone over each of these criteria in detail in prior webinars, so I'm not going to take a lot of time on them now. We're going to show you the growth appreciation period analysis, and then we're going to also do some really cool work on the number of adjustments we make. So we'll summarize, like, the total number of adjustments that we make for Netflix over the last 5 years. Right. And we'll compare that to the average for all companies. So Netflix has got below average adjustments in terms of the number and the dollar value as a percent of market cap. And then we'll highlight the actual income statement adjustments, the number they make, the number we make, the impact, and where it compares. 86% of all companies require more adjustments to reported net earnings. Balance sheet adjustments, you know, we made 10 adjustments to convert Netflix's Reported net assets to invested capital for an impact of $1.6 billion, and 52% of companies make more adjustments. So we're giving you some context. You know, my goal in this section was, you know, everyone can talk about adjustments, but we need to tell people not only what those adjustments are, which we'll do in an appendix, but how big are they, how many of them, and how does this compare to other companies? You know, is this a lot of adjustments or not? Because we realize this work we do in adjustments is very unique. Nobody else is really doing it. So, you know, we got to give you some context, and here's the context on the valuation adjustments. And then details on adjustments, as you see on the webpage and in this report. Again, we're going to show you all the income statement adjustments to get to NOPAT, all the balance sheet adjustments to get to invested capital, and all the valuation adjustments. Again, there's a lot of transparency here. Those of you who've heard me on my podcast and my webinars, Look, we're going to give you more transparency than anyone else in the world. Why? Because nobody else does this kind of work. The research firms we compete against, they all take data fees. They don't have access to their source data. The data provider firms we compete against, they don't do research. We're the only firm that collects our own data. And the reason I created a collection— data collection system is because there's not a data collection system out there good enough. And let me tell you, I've been around the business for a long time. I've talked to some of the biggest firms in the world, competitors, potential partners, hedge funds, other research providers. Nobody's created the data collection system we've created. We have some really cool, unique technology, and it allows us to provide our clients with some really great insights. And yes, we can make a lot of money, and we do, selling some of our more proprietary and sophisticated products to institutional investors. But I want you all to know that I make this available to the masses as well because I think it's important. that everyone have an opportunity to be on fair footing with the Wall Street insiders. So that's a quick overview of our research report. So let's talk about some other research reports. What's good? What's bad? What makes them good and what's bad? Value Engine is, um, one of my, my favorite other providers. Um, the CEO is a great guy and they do some really cool work. And you'll see what they're doing here is they're, they're catering to an audience that's really kind of, I think, looking to get a quick and dirty on what the company is and what it's about. So, this is Alcoa and they're going to give you a business summary, right? And this summary is very similar to what you're going to see on Yahoo as long as it's the same with this contact information. What's pretty— one of the cool things I like about this report is this value engine style rating. So, they give you like the different kind of ratings for different types of investors, right? And I noticed how they have like classic value investor. And conservative investors like they're, like they're different. Um, I think value investing is, uh, is conservative, but it's cool that they're giving you the different types of investing strategies. I think that's a, that's a neat idea, and it gives you the ability to look quickly and find out a lot. Now, when it comes to some of these ratios, these are great standard accounting ratios, also things you can get from Google Finance or Yahoo. They're the basics. The PE, the PEG ratio, the price-to-sales ratio. These are ratios that are very popular, but they're also quite flawed. They're based on accounting earnings. The Journal of Corporate Finance, sophisticated research, sophisticated investors, they've filled many, many volumes of magazine articles and books as to why these ratios can be misleading. You've heard me say, Look, Wall Street likes you to look at these numbers because they can manipulate them. So this is great data, right? And they got a nice little summary over here, P/E ratio, P/E rank. But again, you're looking at a P/E. Now, if P/E is the way you want to go, this is a great research resource. But look, you know, we dedicated our research firm to giving you a better sense of earnings because valuing— because earnings aren't reliable and using a price-to-earnings ratio is not reliable. And the PEG ratio obviously is going to be flawed too, because again, it's all based on accounting earnings. And if you don't believe me that accounting earnings can be unreliable, don't just take it from me. Let's take a look at this article from the CFA Institute. And it talks about the top 5 accounting mistakes analysts make. And they're talking about analysts here, right? Not your retail investors. A great article. Talking about basically big mistakes. And number 1 on the list, number 1, using the generalized financial statements, that is the reported earnings. Okay? Not a good idea, especially from the data providers that drive the research reports that we're talking about today. So, they're using financial statements that have been generalized or normalized in a way that's not good. And, you know, that's, that's not good either. And then, you know, look, not only are those financial statements not very reliable, but you miss the importance of the interactivity of those financial statements. Just looking at any one financial statement, whether it's the balance sheet, income statement, or cash flow, gives you a good perspective on the company, but it's incomplete, right? Just like the story with the blind men and the elephant. Each blind man puts a hand on the elephant and each one describes what he sees or what it is, and they all describe radically different things because they're touching a different part of the elephant. And that one small, narrow perspective is very misleading, and only when you collect them all together can you understand. And honestly, that's a lot of sort of a good analogy for what New Constructs does. We've got people that aren't blind And we've got, you know, with technology, we have thousands of hands on the elephant is effectively what we're doing for you. Not creating apples-to-apples comparisons in time. All my analysts will tell you when they come through our training program, there's 2 things that we pound into everybody, and that is, number one, it's important that our analysis be accurate, and second, and almost just as important, everything is apples-to-apples. That's a big part of our focus. Not adjusting statements for distortions. All right, there's a lot of one-time things that are buried in the databases that you're not going to get fixed in any of these other research reports. And guess what? Not reading the footnotes. You never heard me talk about that before, right? So coming back to the value engine, good stuff if you want to rely on reported accounting data, or even worse, generalized reported accounting data from a database provider. Okay, this is interesting because a lot of people do rely on this stuff and look at it. And look, a lot of what New Constructs is about is just making sure you know what you don't know, know what you're getting into. This research is not going to be long-term, I believe, very helpful to you. And then of course you get some nice balance sheet, income statement, and cash flow data. And the guys here at Value Engine are kind of giving you for a very cheap price, you're getting access to a lot of information. That you can quickly use to, you know, do a lot of work. Um, almost all of this is freely available as well on Value Engine— I'm sorry, on Yahoo or Google Finance and a lot of other sites that actually are more sophisticated and provide more information. So, um, but they're putting it for you all in one spot in a PDF. If that's something you like, then that's something that can be helpful to you. Here's a report from S&P Capital IQ. Capital IQ is probably like one of my favorite, you know, other research firms. I think Capital IQ folks do some good stuff. S&P ratings business is, you know, has come under fire recently. I think we did a nice article, maybe even a podcast. I know Kyle and Andre and Alan did a nice write-up on the big settlement that the S&P guys had to do because basically They said that you shouldn't have trusted our ratings to begin with because we never said they were good, and they paid a lot of money for that because it's kind of like, you know, you can't put yourself out there as a trusted source and charge people money for ratings and then at the end when they go bad say, ah, you really shouldn't have relied on us anyway. Now, I got a kind of a right to say that to you because I've been telling you for a long time, don't trust these big rating firms or Wall Street guys for research. Because they're going to be focused on accounting numbers, as we see here, right? And they're using database numbers as well. These are not built-by-hand analysis, right? And so this is a pretty detailed report. This is a really pretty neat, like, chart. I'm not sure I can quite figure it out, but I'm sure if you look at this for a while, you know, you'll— it'll be easier to follow. They got a kind of quick updates here on where they think revenues are going and sort of the investment risk rationale. This is, this is not totally boilerplate, but it's not exactly insightful, customized, or unique. You know, we don't do that either, right? That's not our thing. Um, and but it's not like getting a Wall Street report, right? You've got a nice big overview of what's going on. You know, you also got a target price, which is interesting, right? Based on a PE. Okay, and I'm not so sure how that's helpful. They're going to give you some, again, EPS projections. I'm not so sure how much value that adds. Uh, they've got some nice little charts here on the second page. Uh, you know, their expanded ratio analysis, basically, you know, again, accounting data. Uh, not, not, not going to do a lot to differentiate, right, what you're looking to do. Uh, and again, I'm going to throw the word differentiate around there a lot because look, when I was raised in the business, I was taught this fundamental fact, which I believe to be true. You don't really have a right to an investment opinion unless you have a differentiated view from the market. Why should you make an investment in a stock if you believe the same thing everyone else believes? Because that would mean all the expectations for future cash flows that you believe for the company are already reflected in the stock. This is for active investors, of course, right? If you're a passive investor, then you're invested in the stock market because you just want to be in the stock market as an asset allocation thing. When it comes to individual securities, you need to have a reason to be in that, and that reason needs to be that you have a differentiated view. Otherwise, don't buy it. So, I'm going to really try to focus on differentiated views. What's going to give you a differentiated perspective On the company, and it's not the reported accounting data, per-share data, income statement or balance sheet analysis. So you got a nice little individual write-up here on the sub-industry. You know, this is not too dissimilar to, to what you get from, you know, a Value Line. You know, you've got a guy covering a lot of different stocks, they'll do a quick write-up and they'll use that as boilerplate again and again. But again, you know, sort of similar to the value engine, a lot of data in one place can be very helpful. Zacks, this is a quick snapshot of the Zacks analysis. They're going to focus a lot on projected estimates and getting a sense of where those mean. And this is a very popular strategy these days because companies tend to move a lot whether or not, you know, based on How well they hit their numbers. And so, a lot of people just focus on that. They play the game, you know. And there are big— there are firms that have come out that do a great job on just playing on that theme. Estimize, great new technology and company that focuses on the estimates game. And let me say, it is a game, all right? If you're going to be playing this sort of what's the market reaction going to be to the earnings number? And we have to go back to one of the previous webinars when we talked about the difference between investing and speculating. And if you're looking to predict the near-term direction of price or the day-to-day psychology of the market, you, my friend, are a speculator and you're not an investor. That's okay. Nothing wrong with being a speculator. But I just want to understand— want you to understand, for the purposes of our conversation here today, I see a big difference. So you got some Cool stuff on the analysts and the number of revisions or the number of analysts we're dealing with, the number of revisions, up, down, etc. Sometimes it's changed a lot, sometimes it doesn't. You got some decent stuff you can see, you know, same kind of information you get straight out of Yahoo. A lot of times these guys are basically creating reports based on the data that's used on Yahoo, which comes from Reuters a lot of times. So it's just a data feed a lot of people have. And you can get a sense of the magnitude of the change in estimates by just looking at what the old number was and what the current number is and looking at some industry growth rates. Again, I think we're seeing a preponderance of a focus on traditional accounting data. This Morningstar report on Berkshire Hathaway is interesting. A lot of deep write-up. I think this analyst has done some interesting work here to write up talking about Berkshire Hathaway. I think you'll see some of this on some of the really big companies. You'll get a nice write-up. Is there anything surprising here? Not really. I think it was interesting here when they talk about the risk is obviously such a big company, how can they continue to grow profits? On the corporate governance side, they talk a little bit about how one of the things they don't like is that he's both chairman and CEO, but the guy's been also one of the biggest advocates of intelligent in value investing and allocation that they'll make an exception for him to be the best, to be a good guy, to be chairman and CEO. If there's one guy you want to be chairman and CEO, he's probably the one, right? And they did a good job of talking about what the bears say and the bulls say. You're not getting a lot of quantitative support here, but this could be what you want. We need to learn about the company. One of the things that I will take a little bit of exception to is their notion of wide moat. Morningstar tends to talk about the moat a lot, but they don't really do it in a quantitative or, in my opinion, correct way, complete way. There's no discounted cash flow model to measure the implied growth in the stock price. And that at the end of the day is what matters. What is the market implied width of the moat? That number for us is the growth appreciation period. For Netflix, it's more than 100 years. That's how wide the moat is at Netflix. That's talking about the moat and being specific, which I think in my opinion is honestly, it's a little more helpful. So, I'm starting to get some questions here. I'm going to get to you really quickly, but I want to talk a little bit about Wall Street reports in general, you know, and how they're different because we talked about some non-Wall Street reports here. And what you're going to see from these folks in general consistently is accounting-based data that's taken from a database that really, even as fancy as it looks and how nicely it's put together and the big fancy name on the side here, You're not getting a lot of value-add, my friends. You're getting packaging of data that everyone else already has. And by the way, it's not exactly high-quality data. So, that's the long and short of it. Now, what are you going to get from Wall Street? Well, I've talked about Wall Street a lot in the past. And, you know, look, I think nothing says it better. Than a recent Wall Street firm coming out and actually admitting that they made a horrific call. You know, the interesting part about this situation is that we wrote an article and I met with some guys at Stifel not too long ago and suggested, hey, you know, we got some stuff that can warn you about this. And we wrote an article about— what was it called? It was Beware These 3 Words. These three letters, IPO, right? I think I showed you guys in this one, so I won't go into it. But we warn people about this. Sorry about that. There's a warning, very clear warning, very good analysis. But I think this speaks to. What happens when you can rely on Wall Street research? Um, you know, look, we made a horrific call on the stock when we initiated coverage in January 2015. Uh, anyway, you have to keep in mind Wall Street research firms— well, let me just put a question to the group before I get to your questions. Um, one question for you: who knows how much Revenue the research departments at Wall Street firms bring in? Okay, we've got one guess. You're way too high. Here's a clue: you can't be too low. That's right, it's zero. Who makes the decisions at the investment bank? The bankers. How do bankers make money? IPOs. Secondaries and selling stock. So, if the research isn't helping them sell stock, what happens? You get fired. If you don't believe me, look up Mike Mayo, former Credit Suisse analyst, one of the best bank analysts of all time. He got pushed out of Credit Suisse because he was too good an analyst and not a good enough banker. That's just the way it works, my friends. So, quick questions. We've got 5 minutes for questions. We're going to knock out as many as we can. Do you factor in EPS in any way into your models? Yeah, we use EPS. We use it to figure out how far off the company is from, um, reality, right? So misleading trend means what are the accounting earnings telling you versus what are the economic earnings telling you. And when you see misleading trend, that means accounting earnings are positive and rising and economic earnings are negative and declining. So Key point here. Yeah, we look at EPS, but we look at it as a contra-indicator. We don't look at it as something to track. We look at it as something to only track when it's misleading, or it's only helpful really as a way to get a sense of when the company's misleading you. And that's something we feature. So we look at EPS in a very different way. We're looking at EPS from your perspective. From the perspective that sophisticated investor looks at EPS, which is how inaccurate is it? Because we all know that it's inaccurate. All right? It's not just— you don't have to be a CFA. You'll see articles. Just look up how to manage earnings. Forbes, Fortune, very popular magazines have been talking about this for years, how earnings get managed. Trust me that it's not— they're not reliable. Good question on price action and volatility. Do we track that much? No, we really don't. We're not really not going to be that helpful on the technical front, quite candidly. You know, technical research, charting stuff has always kind of been something that, you know, I've honestly grown up in the business, have always sort of felt a little bit hocus-pocus. But it works. It works. It works for a lot of people. And I remember when I was on Wall Street, there were a couple guys, um, a guy, Solomon Smith Barney. I don't remember his name. Um, great guy. He had an awesome career in technical analysis. And there was another lady who was really good. Uh, and a great book I was given, Market Masters. And there are some people who, who, you know, they make it work. And I think that over the last 15 years, there's been a huge trend, huge increase in the number of people using technical tools and momentum tools. And that sucked more people into believing that they're helpful. And this trend has been created by the fact that we have a whole new group of investors in the market today versus 15, 20 years ago. 15, 20 years ago, there was no such thing as E-Trade. TD Ameritrade, Scottrade, these things did not exist. Individual investors weren't supposed to invest. That's what you had advisors for. Technology since changed that. And they've come in in droves and for good reason. It's good to empower people. And then there's CNBC and MarketWatch.com, CNBC.com, Seeking Alpha, all these things to help individual investors. Make decisions daily, hourly, by the minute, by the second. The day traders, huge day trading boom. By the way, the day trading boom was the biggest when electronic trading was first made available. When I first moved to New York, some of my good friends were day traders. And I remember they were talking me into it one time and they said— really good friend of mine, played football with him in college, still keep in touch with him, he's still in New York and he made a boatload of money day trading. The early guys made crazy money because there was no competition. They were taking advantage of unnaturally large market maker spreads before the market makers even knew what was going on. And it was shooting fish in a barrel. There's really no money to it, no brain, no brain power to it at all. But that didn't last for long. But I remember my good friend, we were out one night in New York, we were in our early 20s, and he says, yeah, you gotta get in this day trading thing, Trainer. I was like, really? And he's like— I was like, well, tell me what it's like. How do you do it? He goes, yeah, you know, the ideal trade happens in about 18 seconds. And I'm like, what do you mean? He goes, well, you know, you put in your bid and you see the price action go up and you sell it. That, you know, ideally takes place like 18 seconds. And I go, so based on like what analysis? He's like, yeah, you don't need any analysis, man. I'm like, what are you talking about? He goes, no, it just goes up, you know, and you see the ones going up and you buy those and you sell them real fast. I'm like, well, how is that sustainable? And he goes, what? And I go, well, I mean, how do you really create like a competitive advantage and a career around that? Where's your like intellectual capital? And, um, you know, then he offered me a shot or something, the conversation ended. And so, uh, that's what it's about. Um, and so we don't— so anyway, that's, that's maybe a failing of ours, but what we're trying to do with New Constructs Research is Focus on something we do really, really well and not try to mix the message. We're focused on giving you the best quality of earnings evaluation numbers and to give you protection from the Wall Street propaganda. And to circle back real quickly on this day trading thing and the individual investors, look, the easiest research tools to put in front of an individual investor, self-directed investors for Scottrade, for fidelity.com, for E-Trade, for all of them. It's technical tools, charts. They're easy to read and understand. To a man with a hammer, everything looks like a nail. Or in other words, this huge change and shift in investor population where you're creating a whole new segment of investors, the self-directed investors, and they're all looking at similar screens because they're all looking at technical tools because that is what Fidelity and E-Trade and everyone put on the desktop because it was quick and easy. It's easy to understand, easy to talk about. And by the way, it changes every day, so it drives more trades. To a man with a hammer, everything looks like a nail, right? Everyone was using the technical tools, which made the technical tools seem more and more like they worked until they didn't, and you got blown up in 2008. And today people are getting blown up on individual stocks because The trend analysis and technical analysis works until it doesn't. The problem is you have no idea when it's going to stop working. So we are at our 30-minute time limit. I'm going to ask— answer one quick question because I can do it quickly. What percentage of our stocks get an attractive or very attractive rating versus dangerous or very dangerous? So 375 out of 3,000. Get attractive and very attractive, and 1,700 out of 3,000 get dangerous or very dangerous. So, you know, about 13 or so percent are attractive and very attractive, where well over half are dangerous or very dangerous. Compare that to the ratings of other firms. And you'll see that we are— have a much more, I would call, honest skew. Other people might say negative. I would call honest. There are really not that many great stocks out there. That's why it's a semi-efficient market. In a perfectly efficient market, there'd be no good stocks because they'd all be perfectly valued. But we recognize it's a semi-efficient market. And that means there aren't that many good stocks out there because we've got a very sophisticated market. A lot of smart people out there. And the smartest people, of course, are the people on this webinar right now. And they're using the best tools they can to make the best decision they can. And so there's not going to be that many good stocks. And that's why I think one of the things I like to talk about is how few good stocks or how many companies really get a good rating in our system. And it's not that many. Andre's telling me I need to take a look at the last page of the Capital IQ report real fast before we go. Something he wanted me to point out on that one. Oh yeah, he says it has the breakdown of their, of their ratings. And so you can see here, Very few dangerous or very dangerous ratings, just 9%. Mostly holds and a good chunk of buys. The quantitative ratings are a little bit more balanced, but you still got as many buys as you do sells. So thanks for that, Andre. OK. Okay, that's it. Thanks very much for your time today. Remember, you can track us on Twitter. We had some really good big-time tweets today. Herb Greenberg of CNBC was retweeting us, as were some— a lot of other folks. So we got some great stuff going there. Email me or Andre and Kyle and Alan, our publishing guys. We'd love to get feedback. You can email us at publishing@newconstructs.com. Support@newconstructs.com, uh, and me at david.trainer@newconstructs.com. We want to hear from you. We love doing these webinars. We're going to post this webinar to the site, uh, as we do all past webinars. You can now see this in the education section. Kyle built a really cool thing for our webinars here. You got the sign up for the weekly webinar here and past webinars. It lives on the education page. We think that's awesome. I think that's awesome. I love what we've done here and we're going to keep doing these. We love the participation. Thanks so much for all the people showing up. Invite your friends. I think we have up to 500 seats and we're, you know, we're mostly, you know, we're not quite halfway there. So we got a good number. We got plenty of room here for more people to come and you're welcome to invite more folks. Awesome. And send us questions in the meantime. And thank you for listening and for being with us today. Thank you.