Case 086Equity research and stock pitchesWarm up
A private wealth client asks your view on a tractor maker trading at 14 times earnings after a 30% fall on two weak monsoon quarters. Give a brief bull and bear case and a view in under two minutes.
1The situation
In a final-round interview for a wealth management role, the interviewer plays a client and asks for your view on Krishiyantra Tractors, an invented listed tractor and farm equipment maker. The stock has fallen from Rs 1,000 to Rs 700 over six months after two quarters of weak sales, blamed on a poor monsoon.
Trailing earnings per share have dropped from Rs 60 to Rs 50, so the stock trades at 14 times earnings against about 16.7 times before the fall. Over the last ten years it has traded between about 11 times earnings at troughs and 16 times through a normal cycle. The balance sheet carries little debt. You have two minutes.
2Your task
Give a short bull case and bear case, each resting on one number, and close with a view and what would change it.
Quick check
At a mid-cycle multiple of 16 times, what earnings per share does a Rs 700 price imply?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
A short pitch is a view, the one number behind each side, and what would change it. Bull: a normal monsoon lifts earnings back to Rs 62, worth about Rs 992 at 16 times, 42% up. Bear: a third weak monsoon holds them at Rs 42, worth about Rs 462 at 11 times, 34% down. At 16 times, Rs 700 already prices earnings near Rs 44. View: a reasonable cyclical case for a patient holder; the next monsoon would change it.
Step 1What does a two-minute pitch have to contain?
Four things, in order. A one-line view, a bull case and a bear case that each rest on one number, and what would change your mind. A friend asking whether to see a film wants the verdict, the best and worst of it, and whether it depends on liking the lead actor, not the plot summary. The interviewer is testing whether you can reduce a company to the few numbers that drive it and commit to a view without overselling it. For a cyclical company like a tractor maker, the driver is the farm cycle, so both cases should be about earnings at different points of it.
Step 2What do the bull and bear cases rest on?
Bull: tractor demand follows farm incomes, and farm incomes follow the monsoon. If the next monsoon is normal, earnings recover to about Rs 62 a share, roughly where a normal year left them, and at the stock's usual mid-cycle 16 times that is worth about Rs 992, 42% above today. Bear: a third weak season, with dealer inventory already high and rural lenders cautious, holds earnings near Rs 42, and at a trough 11 times that is about Rs 462, 34% below. Neither is a forecast; each is the price that would follow if one condition held.
Step 3What is the market already assuming?
This is the step that turns a list into a view. Divide the price by a normal multiple: Rs 700 at 16 times implies earnings of about Rs 44, close to the bear case. So the stock is cheap on today's earnings only if the cycle turns; on trough earnings it is about fairly priced. The upside of 42% against a downside of 34% is a modest tilt, not a bargain.
| EPS, Rs | Multiple | Value, Rs | From Rs 700 | |
|---|---|---|---|---|
| Bull: normal monsoon | 62 | 16x | 992 | +42% |
| Today | 50 | 14x | 700 | 0% |
| Bear: third weak monsoon | 42 | 11x | 462 | -34% |
| Implied by Rs 700 at 16x | 43.8 | 16x | 700 |
Step 4How would it sound in two minutes?
Something like this. Krishiyantra is a cyclical business at a low point in its cycle, and the price already reflects much of the bad news. The bull case rests on one thing, a normal monsoon bringing earnings back to about Rs 62, which at its usual 16 times is near Rs 992. The bear case is a third poor season holding earnings near Rs 42, which at a trough multiple is near Rs 462. At Rs 700 the market is paying a normal multiple for close to trough earnings. My view is that it is a reasonable cyclical holding for someone who can wait through a monsoon or two, sized as a small part of a portfolio, and I would change that view if dealer inventories kept rising after a good monsoon, which would point to lost market share rather than weather. The limit to say aloud: this view depends on the ten-year multiple range holding, and a structural change, such as an electric-tractor entrant, would reset it.
Where candidates lose it
Candidates spend the two minutes on the company's history, product range and market share, and run out of time before the view. The interviewer wants the verdict first and two numbers behind it.
The second miss is calling the stock cheap because it trades at 14 times after a fall. For a cyclical company, a low multiple on falling earnings can be expensive; the useful move is asking what earnings the price implies at a normal multiple.
What the interviewer asks next
- What one data point would you check each month to track the bull case?
- How would your pitch change if the company carried debt equal to two years of operating profit?
- The client already holds two other rural-demand stocks. Does that change your view for him?
Asked at Northern Trust, Private Wealth Management, Chicago, 2022 (Wall Street Oasis): was asked about my view on some stocks and I gave a brief pitch
Company names and figures are illustrative.