How bankers judge investment banking investment questions

In Uncategorized | 6 minutes read

Wow, did I SUCK at this question the first time…

I blabbered on about all my shite stocks, some Ghanian gold mine and probably mentioned how I would dry hump Warren Buffet for a tip if I ever saw him outside Dairy Queen.

Yeahhhhhh, not great.

But I soon put together a killer answer for this and started to knock it out of the park EVERY…SINGLE…TIME.

In today’s lesson we’re going to see a STUDENT answer it – a pretty smart student – and then you’re going to see OUR feedback (me and the team).

You’ll find out…

…what we loved AND

…what we thought suuucked.

You are literally about to step inside our sick sick minds and see how we judge candidates’ answers.  Please sidestep the moral abyss that is our frontal cortex, and proceed with caution.

So kid…

— If I were to give you $100,000 right now, what would you do with it? —

“As a general idea, I prefer fairly long term passive holdings and I don’t like to chop and change my investments too frequently.

And my fundamental thesis over the next 5 to 10 years is that there’s going to be fairly low inflation, given that where the world is at the moment, where the domestic economy is fairly weak, and the European economy even weaker and potentially going to get worse, and that is a large proportion of the world’s demand is in Europe and the US – demands for goods and demand for services – and then you have a huge amount of supply which has been built up over the last 10 to 20 years, particularly in places such as China.

So what’s happened is that demands moderated, but supply has built up so much is that I think there is an underutilization of assets which is a deflationary force.

And this lack of demand, and I suppose glut of supply, is going to lead to a long term period of fairly low inflation, even though central banks are printing trillions of dollars, I still think that the deflationary forces are going to win.

And you are going to be in a fairly low return environment, with potential for periods of economic weakness or recessionary growth both here in the US and in Europe in particular.

In that context from a total shareholder return perspective, so from capital growth plus your dividend or distribution yield, I think what’s going to be really important is that you grow your dividends.

And that’s where I would be looking.

Now that might all sound very conservative given I’m quite young, but I’m looking to protect on the downside with fairly safe stocks that pay strong dividends.

And so if I was given $100,000 I would look at 3 to 5 companies which have strong market positions, have relatively capital light businesses – business which are very high users of capital, such as the airline business, a classic example, or a mining company, they will typically be very exposed to cyclical movements in the economy, and they will also be voracious users of capital which makes it very difficult for them to pay high dividend yields.

So I would look for a company with a very strong market position which isn’t necessarily so heavily tied to the ups and downs of the economy, which uses fairly modest amounts of capital in its business and can therefore maintain its distributions.

So even though you might not get any movement in share price over the next 3 to 5 or 10 years, you will be getting strong dividends and that’s going to generate a majority of the returns.

And this is in an environment where fixed interest products such as treasuries or very safe corporate bonds might only be yielding you inflation, at best, at say 2 or 3%.

So you’re not really getting ahead by owning fixed interest products with supposedly very good risk credentials, European treasury debt aside.

So I’d be looking at strong corporates that pay solid dividend yields.

There are plenty of franchises you can think of, might be like a Coca Cola, might be like an insurer, or assets being sold on a distressed basis, take Munich Re for example, a reinsurer in Europe that has paid a growing dividend for the last 40 years, and even though a lot of European assets are being priced at distressed levels at the moment, it might still have market power, be sufficiently well capitalized to continue paying a very strong dividend.

I’d be looking at close to 100% in stock, and if not 80% in stock and then maybe a bit of cash on the side which you can then utilize into say treasuries or cash or other very liquid cash equivalents, and then you could utilize that into any downswings in the equity markets to pick up mispriced assets.”

Fanf**kingtastic kid!

Now let’s move onto our thoughts…

— Our STRAIGHT UP hold-the-BS feeeeedback on the answer —

We LOVED this answer because the thinking that went into it was immense.

But we also HATED this answer because it was like the ramblings of a 4-coffee-fuelled analyst at about 3am!

The answer also missed an important point…asking who the money was to be invested for…you (yourself) or some hypothetical investor (eg a 60 year old retiree).  The student just assumed we were talking about giving him the money so he could invest it for himself.

But since this is often asked to test out your fund management skills on behalf of a client, this is a dangerous miss.  But not too major…bankers will usually let you rant ahead on what you’d do with the money for yourself.

Okay, back to it…

So the student spends a lot of time talking about the way of the world economy, and although it’s great, its all loaded at the front of an answer.  This is baaaad.

Bankers will be faaaaaalling asleep thinking;

“What’s this student on about, why don’t they just answer the question?”.

ie you should first tell them what you would do with the money, and then set about explaining the reasons.

We just need to FLIP this student’s answer on it’s head.

The actual answer he gives is great, but it’s the reasoning we care about…and it woooorks!

You see, just like in maths class it doesn’t really matter what answer you arrive at (eg here, 80% stocks, 20% cash), but rather how you explain it.

Whilst the student did well explaining how certain assets classes were providing very poor returns, and thus why stocks were attractive, what was particularly great were his references to his personal situation…ie tailor making the answer to the needs of the client…which in this case he decided was himself!

So overall, great answer, just could have been delivered in a much clearer, smarter way.

P.S. This lesson was extracted straight from our very popular Inside Investment Banking Course.  If you’re serious about breaking into banking, check it out now.

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