What motivated you to write The Little Book of Investing Like the Pros?
Josh Pearl: My co-author and I had a lot of success with our maiden book, Investment Banking: Valuation, LBOs, M&A, and IPOs. We originally wrote the book as were beginning our careers in investment banking and saw a void in the market where individuals coming out of undergrad and MBA programs, as well as career changers, didn’t really have a resource available to teach them how to perform the crux of the investment banking work, including valuation, structuring deals, and execution. A lot of the tools that were available at the time were typically grounded in finance theory and written by professors, versus actual practitioners. So, we sought to fill this void in the market and created step-by-step processes for learning the core investment banking skills.
Ultimately, after eight years in investment banking, I moved to an investing role, or what they call the “buy-side”. Once in investing, I quickly realized that even though there are a lot of transferable skills from the world of investment banking to investing, it is really quite different in terms of how those skills and tools are employed. While my transition was not difficult, there certainly was a l learning curve. So, if I’m experiencing that with all this formal training, then I’m sure there are a lot of individuals out there who are beginning investors or who want to understand how professional investors make their investment decisions who need a guide. And this would even apply to even career changers — those who are transitioning from investment banking to hedge funds.
As with Investment Banking, we created a framework and a step-by-step process for how to source investment ideas, perform due diligence, perform valuation, and ultimately how to construct a portfolio. We believed that the step-by-step processes we created for Investment Banking were highly transferable to the world of investing. Our publisher, Wiley, had this great series called the Little Book series targeted towards individual investors and we thought this was a great format for us as well. That was the initial genesis of The Little Book of Investing Like the Pros.
What are some of the key aspects of investing that you discuss in your book, Investment Banking: Valuation, LBOs, M&A, and IPOs?
Josh Pearl: For Investment Banking, we really tried to mirror the format of an investment banking training program as well as the learnings from our first few years in the trenches. But to take a step back, the catch-all term for investment banking is pretty broad. Within investment banking there are a lot of different specialties. For example, my co-author spent a lot of time in mergers and acquisitions and equity underwriting, and I spent a lot of time in leveraged buyouts and restructuring. We really sought to cover the whole range. We started with a chronological base — the skills that you will learn throughout your career, and it gets more difficult as we progress through the book.
We started with basic valuation methodologies, the first being what they call comparable companies analysis, which is very similar to what happens in real estate, when you’re trying to understand how much your home is worth by comparing it to your neighbors. You notice differences. One’s a little bit bigger. One’s got a better facade. One’s got more garages. One’s got a finished basement. So, comparing companies is similar. You’re looking to value a company based on how peer companies are valued in the market. There are a lot of nuances there. One has higher or lower margins. One has a stronger growth profile; it’s growing faster. One has less leverage. One has more leverage. One has a better management team. One has a worse management team. Then we outline precedent transaction analysis, which is seeking to examine what similar companies have sold for in the relatively recent history — the last three-to-six months, the last couple years — and use that as a basis for valuation. And sometimes that’s more relevant because it measures what someone is willing to pay for a particular business.
Then we go through discounted cash flow analysis. What does a company expect to produce in cash flow, and how do you discount that? And then we move on to more advanced topics like leveraged finance, leveraged buyouts, how do private equity companies structure LBOs. There are a lot of nuances there. LBO analysis is one of the more complex valuation methodologies. And then we go into detailed M&A analysis, how to build a merger model, and how to structure a merger. Finally, we go into how to value an IPO candidate and how to underwrite an IPO.
There’s a lot to it. Basically, it’s meant to serve as an all-encompassing tool for somebody who wants to get a job in investment banking. And all these tools are the building blocks for investing. Because investing at its core is centered on paying the right price for an asset at the right time.
So, why do you focus on a fundamentals-based investment strategy in The Little Book?
Josh Pearl: A fundamentals-based investment strategy is really grounded in the basic business model inherent in a company, i.e., what does the company actually do? How does it generate revenue? Is it a price/volume equation? What is the product or service they provide? And then breaking these and many other items down to better understand the business. Is market share increasing? Is the market size increasing? Is that product or service becoming more valuable? Can they charge more? And then what does that all mean in terms of the financial equation. What is the company generating in terms of earnings? Are those earnings growing or shrinking? What is the company’s cash generation? How is management using that cash? Are they going out and acquiring other companies? Are they investing in the business through new capital projects? Are they buying back their own stock? Are they repaying debt? Are they paying out a dividend?
So, basically if I were to trim that answer down, it would be more like: What does the company do? How does it make money? And, how does the company spend that money to create value for shareholders?
What was the most surprising or unexpected thing you learned when you started your career?
Josh Pearl: A couple things I’d say: One, is the people. There are a lot of war stories about Wall Street. A lot of them are grounded in the ethos of the 1980s; you know, movies like Wall Street, for example. And there’s this kind of misnomer that says a lot of a-holes work on Wall Street. I’ve just found that not to be true. I was very fortunate to work with some incredible people throughout my career. In general, they’re just really good people. So, that’s one thing that was surprising, to meet these salt-of-the-earth people. Of course, there are a few bad apples here and there, but in general I’ve been very impressed, on a personal level, by the high quality of the people. It goes without saying, you’re working with some smart and talented individuals, and that’s invigorating to be around.
And then the other thing that’s surprising is that, in general, you’re starting in investment banking right out of college. And yet, the level of responsibility that you get early on is really astounding. I mean, you are a core part of a deal. After three-to-six months on the job, maybe a year, you have real client responsibilities, and your opinion matters. Early on, I remember my first LBO: I’m on the phone with the CFO of the company, walking through the financial model, and they’re asking questions, and you’re working with people that are in some cases three times your age on the client side. It’s really a lot of responsibility and that’s a great experience.
How did you become interested in a career on Wall Street?
Josh Pearl: I grew up in Cleveland, Ohio, and one of my mentors was an investment banker who worked for Drexel Burnham Lambert, which was one of the innovators of a lot of the transaction structures that we use today, such as leverage buyouts. He is an individual that I really admired, both the way he lived his life personally and professionally, and that kind of sparked my interest. Then, in my senior year of high school all my friends and I worked at the local grocery store; they’re working in the checkout lines bagging groceries, and they’re getting cash tips. I was working in the dairy section and I was pouring out spoiled milk all day and restocking shelves. And I’m thinking, this is just not for me even for a high school job.
So, I got an after-school job working at a branch of Merrill Lynch. And there I was exposed to a lot of IPOs because many of their clients were getting allocated IPOs. And I was figuring, you know, there’s somebody who’s behind these deals and I think that’s what I want to do. And then when I got to university, on Day 1 of my business 101 class, one of the alumni was an investment banker and he came to speak to the class. He talked about what he did, and that sounded so interesting to me.
You’ve been an innovator throughout your career. What do you think will be the next big idea that will change through investing for investing management?
Josh Pearl: In terms of innovation and finance overall, I think a lot of what you’re seeing is a lot of processes being automated. I think there’ll be a lot more of that. I think you’re going to see private equity continue to expand. That really is where the institutional capital is going right now. I think you’ll see the private markets in both credit and equity continue to expand. I think a lot of the innovation we’re seeing also has more to do with access to alternative products for the retail investor.