Investment Banking For Dummies

Matt Krantz is the personal finance and management editor at Investor's Business Daily. Matt's recent books include Online Investing For Dummies and Fundamental Analysis For Dummies.Robert R. Johnson, PhD, CFA, CAIA, is a Professor of Finance at Creighton University, where he teaches in the Master of Security Analysis and Portfolio Management Program.

• Introduction 1About This Book 1Foolish Assumptions 3Icons Used in This Book 3Beyond the Book 4Where to Go from Here 4Part 1: Getting Started With Investment Banking 5Chapter 1: Introducing Investment Banking 7What Investment Banking Is 8The role investment banking plays 8How investment banking differs from traditional banking 10The services investment banks provide 11How investment banks are organized 12The current lay of the investment banking land 14Types of investment banking operations 15How investment banks get paid 15How Investment Banking Is Done 17Finding the financial statements 18Understanding the importance of financial statements and ratios 18Zeroing in on past transactions 18Seeing the value of fixed income 19Turning Into an Investment Banking Pro 19Putting the discounted cash flow analysis to work 19Seeing how leverage becomes a force in investment banking 20Pinpointing buyout targets 20Putting Investment Banking to Work 21Staying in compliance with the rules 21Looking beyond the published financial statements 21Making adjustments to financial statements for comparability 22Chapter 2: The Purpose of Investment Banking: What Investment Bankers Do 23Putting the For-Sale Sign on Corporate America 24Mergers and acquisitions 25Leveraged buyouts 27Private business sales 29Initial public offerings 32Helping Investors Decide Whether to Buy or Sell 36The importance of research 36What do the analysts do? 37Digging Into the Role of the Trading Desk 38Why investment banks are into trading 39How investment banks turn pennies into billions 40The type of analysis used in trading operations 40Chapter 3: How Investment Bankers Sell Companies 43Getting Companies Ready for Sale on Public Markets 44Meeting the requirements to make an IPO happen 45Writing the prospectus 47Supporting the IPO: Making success last 51Seeing What Sell-Side Analysts Do 53The goals of the sell-side analyst 54What investors look to sell-side analysts for 55Spreading the word: Disseminating sell-side research 55Examining a Sample Research Report 57What to look for in the document 57The main sections of a research report 58Ways to look beyond the “buy” or “sell” 59Chapter 4: How Investment Banking Is Used in Mergers and Acquisitions 61Come Here Often? The Basics of Mergers and Acquisitions 62Kinds of mergers 62Why companies merge instead of simply growing organically 63Firms that make attractive acquisition targets 66How companies identify firms to merge with 67The nature of the merger: Friendly or hostile? 68Tools Used to Analyze the M&A Deal 70The role of the buy-side M&A advisor 70The role of the sell-side M&A advisor 75Why Many M&A Deals Go Wrong 76Misplaced incentives 76Faulty analysis 77Overstated synergies 78Culture wars 78The winner’s curse: Overpaying 78Chapter 5: How Investment Banking Is Used in Leveraged Buyouts 81In This Corner: Introducing the Players 82Investment banks 83Big institutions 84Management 85Stock and bond investors 86Aiming for the Right Targets in a Leveraged Buyout 87Identifying companies that can work in a leveraged buyout 88Appreciating the power of cash flow 89Coming to terms with the return analysis: Internal rate of return 90Finding the Exit 91Setting a target for exit in time 92Considering how the exit will happen 92Part 2: Digging In: Performing Investment Banking 95Chapter 6: Finding the Data: Documents and Reports 97Finding What You Need on the Securities and Exchange Commission’s Website 98What types of information you can find 98The key types of documents 99How to use EDGAR to pinpoint information 100Getting Data in a Format You Can Work With 105Assembling the tools you need 105Importing financial information into Excel 107Getting in tune with interactive data 109Paying Attention to the Non-Financial Information 110Monitoring news streams for investment banking ideas 110Quickly processing information with aggregators 112Doing research on the key players in a deal 114Chapter 7: Making Sense of Financial Statements 115Income Statements 116Locating the areas of interest to investment bankers 118Tweaking the statement with different assumptions 119Finding investment banking opportunities 120Balance Sheets 121Finding your way around the key parts 122Understanding a company’s financial strength 124Locating pitfalls and opportunities 126Statement of Cash Flows 127Seeing why the cash flow statement is so important in deal making 127Understanding the key parts of the document 127Calculating free cash flow 130Proxy Statements 131Learning about the key players in a deal 131Identifying the management team’s incentives 132Analyzing management pay packages 133Chapter 8: Perfecting the Financial Ratios for Investment Banking 135Valuation Multiples: Assessing How Much the Company Is Worth 136Investors’ favorite valuation tool: P/E ratio 137Going old school with price-to-book 137Putting a price on profitability 138Liquidity Multiples: Checking Companies’ Staying Power 140Deciphering debt to equity 141Getting up to speed with the quick ratio 142Interpreting interest coverage 142Profitability Ratios: Seeing How a Company’s Bottom Line Measures Up 143Why gross margin isn’t so gross after all 144Income from continuing operations: Looking at profit with a keen eye 144Keying into profits with net margin 145Efficiency Ratios: Knowing How Well the Company Is Using Investors’ Money 146Finding out about return on assets 147Digging into return on capital 148Uncovering company secrets with return on equity 149Calculating a company’s growth rate 150Chapter 9: Sizing Up the Industry 153Performing an Industry Analysis 154Understanding why industry analysis is important 154Creating a comparison universe 155Adjusting the industry comparison universe 158Unearthing Company Trends and Common sizing the Financial Statements 159Comparing growth rates 160Comparing leverage 163Comparing various profit margins 165How a Company Stacks Up: Comparing the Key Ratios 166Sizing up valuation 167Comparing total debt-to-equity 169Sizing up companies on their efficiency 170Industry ratios 170Chapter 10: Understanding Stocks and Focusing on Past Transactions 171Introducing Stock 172Characteristics of stock 173Types of stock 174Understanding stock pricing 175Finding Past Transactions 176Tracking the stock market 177Studying private deals 177Looking at pre-IPO marketplaces 179Examining buyouts 179Analyzing Past Transactions 180Knowing what the market will bear 180Knowing when the market is distorted 180Tabulating key ratios for past deals 182Understanding the pitfalls 184Chapter 11: Applying Investment Banking to Fixed Income 185Introducing Bonds 186Identifying the Various Types of Bonds 188Convertible bonds 188Callable bonds 189Puttable bonds 189Floating-rate bonds 189Zero-coupon bonds 190Knowing Their Place: The Position of Bondholders 190Understanding Bond Pricing 192Introducing the concept of present value 192Relating yield to maturity and price 195Playing the spread: How different factors affect bond prices 196Considering bond sensitivity to changes in interest rates 197Tracking the Bond Market 200Debt or Equity: How a Company Chooses 202Part 3: Taking Investment Banking to the Next Level 205Chapter 12: Doing a Discounted Free Cash Flow Analysis 207Gearing Up for Discounted Free Cash Flow 208Computing free cash flow 210Forecasting free cash flow 211Calculating the Weighted Average Cost of Capital 212Understanding why the weighted average cost of capital is so important 213Measuring the cost of debt and equity 214Understanding the capital asset pricing model 217Going for Terminal Value 220Knowing the perpetuity growth formula 220Applying the constant growth formula 221Applying the two-stage growth model 222Stress-testing the results 223Valuing a Share of Stock 224Chapter 13: Structuring a Leveraged Buyout 227Seeing How Leveraged Buyouts Are Structured 228The types of financing 228Understanding seniority and maturity 235Building a Leveraged Buyout Model 236Creating a pro forma model 236Deciding on methods of financing 238Seeing how the results work out 239The importance of taxes in a leveraged buyout 240What can go right and what can go wrong 240Chapter 14: Determining the Strength of a Company’s Return on Equity 243Understanding the Importance of Return on Equity 244What return on equity shows 245Pros and cons of return on equity versus other profitability measures 247How return on equity can help guide an investment banking deal 249Using a DuPont Analysis 250The three-factor DuPont method 251The five-factor DuPont method 253Interpreting the Results 255Cola wars 255What the numbers mean 256Looking past the numbers for insight 256Telling companies how to react to the numbers 257Part 4: Applying Investment Banking 259Chapter 15: Knowing the Rules 261The History of Regulation of Investment Banking 262The goals of investment banking regulation 262Why the rules of today are the result of days past 262How regulations have shaped the investment banking industry 263The Ins and Outs of Modern Investment Banking Rules 264The types of rules imposed on investment banking 264How investment banking rules changed after the financial crisis 267The Rules on Analysts 270Why rules were needed 270The not-so-delicate balancing act analysts play 271What disclosure and compliance are required 272Why Simply Making Rules Isn’t Enough 274Chapter 16: How Some Companies Lie, Cheat, and Steal Their Way to the Top 277Did You Really Sell That? When Companies Aggressively Report Revenue 278Don’t let the sun go down on me 279The truth? 280Lucy, You Got Some ’Splainin’ to Do: When Companies Understate Their Expenses 282What a waste 282Crazy like a fox 283Missed It by That Much: When Companies Overstate Their Financial Position 284Those pesky pensions: The epidemic of firms understating pension liabilities 284We are the world 288Keeping Investors Off-Balance 289Enron’s special purpose 290A mountain of a scandal 292Swap meet 293What Should an Investment Banker Do? 295Chapter 17: Understanding Alternative Investments and Asset Management 297Knowing Your Alternatives 298Hedge funds 298Venture capital 301Commodities 302Real estate 303Currencies and cryptocurrencies 305Digging Into Asset Management 306Attracting investors to asset management 306Creating asset management tools 307Managing Potential Conflicts with Clients 309How asset management can cause conflicts 310How to eliminate and manage conflicts 312Chapter 18: Trying Your Hand at Investment Banking with a Case Study 315Setting the Scene 316The acquirer 316The target 317Considering the Options 317Identifying the options 318Looking at financing 318Creating the Analysis 319An analysis of the financial statements 320Structuring a Deal 322Form of acquisition 323Creating pro forma statements 324Success or Failure 326Part 5: The Part of Tens 327Chapter 19: Ten of the Biggest Debacles in Investment Banking History 329The Dot-Com Boom and Bust 330Tainted Research Scandals 331Enron and the Accounting Scams 332The Mortgage Debacle and Collapse of Lehman 333The Flash Crash 333The London Whale at JPMorgan Chase and Barings Bank 334Long-Term Capital Management 334Bankruptcy in Jefferson County, Alabama 335IPO Allocations with CSFB 336Bad Mergers and Acquisitions Like AOL Time Warner 337Chapter 20: Ten Ways to Improve a Discounted Cash Flow Analysis 339Financial Analysis Isn’t Physics 339Show Your Sensitive Side 340Monte Carlo Isn’t Just for High Rollers 341What Can Go Wrong Will Go Wrong 342It’s Tough to Make Predictions, Especially about the Future 342The Investor of Today Doesn’t Profit from Yesterday’s Growth 343Garbage In, Garbage Out 344Rates Are Falling — It’s a Better Deal! 345Read Your Putt from Several Angles 346The Weighting is the Hardest Part 346Chapter 21: Ten (Or So) of the Best Online Resources for Investment Bankers 349Bloomberg 350Reuters 350Standard & Poor’s 350Renaissance Capital and IPOScoop.com 351The Securities and Exchange Commission 351Moody’s 351MarketSmith 352Index Fund Advisors 352Morningstar 352Bureau of Labor Statistics 353Department of Commerce 353Federal Reserve 354Trefis 354Appendix: Where Investment Banking Came From 355Index 361