SURVEY - INVESTMENT SOFTWARE: BALANCING THE BOOKS
Investment managers and analysts are fortune tellers - only they use computer models instead of crystal balls. But although business modelling is relied on heavily in investment management, the rigour traditionally imposed on IT is often not applied to the spreadsheet models that managers develop in house.
A recent survey by management consultants KPMG found that 95 per cent of models contained major errors which could affect decisions based on the result of the model - 59 per cent of models were judged to have poor model design. Considering just how widely models are used for analysis and forecasting, this is cause for concern.
But modelling technology has recently moved on. The latest software provides easy to use templates which do everything at the touch of a button. Furthermore, packages developed by the likes of Interactive Forecasting allow the user to personalise the model without endangering its underlying calculations.
Using Excel as a mathematical engine they provide a modelling template which removes the need to manipulate spreadsheet cells, programme in paradigms and algorithms and give complex commands to draw and redraw charts.
Interactive's latest software product, if ..valuing by sector, is essentially a valuation tool aimed at individuals who perform financial analysis on companies and sectors. It is visually powerful and can be used for both analysis and communication.
A key feature of modelling templates is the ease with which company results can be assessed, manipulated and then interpreted.
After firing up the software, users are prompted to download historic financial data from a Reuters database of 30,000 companies worldwide. This data can include up to five years' of historical profit and loss and balance sheet items. The integrity of the data can be reviewed by checking the balance sheet balances, but once that's done, the model is ready for use.
Most modelling packages also include a number of valuation methods such as market capitalisation, EBITDA, EBIT and PAT multiples. These can be changed and variables can be adjusted to refine the model and make it recalculate the valuations based on different scenarios. The results of the different calculations are shown in chart format. They are aimed at providing an illustration to stimulate insights into both the performance of the company and the performance of the company relative to its peer group.
With the charts illustrating the calculations, it's then easy to do a quick sensitivity analysis and try out different scenarios. With Interactive's package there is an option for the user to plot a number of different variables against one another on the x and y axis eg market capitalisation versus PE versus shareprice or look at a number of multiples for the individual company or relative to the sector.
But to get the best out of a model, particularly when assessing companies from a portfolio perspective, the full time investor needs to be able to bring his knowledge of the wider picture into the model and assess the company in the context of the market in which it operates.
Take for instance anticipated corporate activity in a sector, which is quite difficult to second guess. if ..valuing by sector allows the user to download a number of the companies in a sector so the user can assess where the greatest scope for corporate activity arises. This may be through looking at the large cash pile of one company relative to the low margins of another or through non financial issues which the investor has identified.
Then, the relationship between a sector and a company needs to be looked at. But while it is quite straightforward to look at the company in isolation, for instance its operating margins or its growth rate for sales, it is more difficult to analyse them relative to the sector. Furthermore, just as with factors relating to the wider picture, it is normally difficult to bring an individual's expertise and knowledge into a model.
To overcome this, if ..valuing by sector allows the user to choose up to eight companies to download and define a peer group. Margin and cash comparisons can be made easily and valuation anomalies or other financial factors which don't "best fit" are identified quickly and accurately.
The launch of the euro and the increase in tie-ups between exchanges across Europe also means that European sector comparisons are becoming more important, as is the need to value companies in the same currency no matter what their reporting currency.
A meaningful valuation is more than merely a calculation. All the factors critical to future business performance and the wider macroeconomic climate need to be evaluated to make accurate assessments.
By effectively using such investment applications private investors can, for the first time, introduce their own judgements and experience into the modelling process and in doing so carry out personalised analysis.