First lessons in US investing

In recent times, interest in international investing, especially in the US markets, has increased. The reasons are many – diversification benefits, premium of many Indian stocks vs multinational counterparts (even when factoring for better growth in India), opportunity to invest in new-age innovative companies, many of which are listed in the US, and, of course, the added benefit of currency diversification as we have seen with the depreciation of INR vs USD over the last many years.

It is often said, ‘Luck is what happens when preparation meets opportunity’. So, if you want to try your luck investing in what has for long been called the ‘land of opportunities’, here’s a prep course for you.

1 Understanding the markets

Before you take the plunge, the first thing to understand is how the broader markets react to various aspects of the economy – Central bank action/comments, changes in bond yields, major global macro news or events etc. The movement of the three major indices in the US – the Dow Jones Industrial Average, S&P 500 and the Nasdaq Composite – must be tracked and their sensitivities to different variables understood. Trying to extrapolate learnings from Indian markets and applying it in the US would be unwise.

For example, Indian markets might react negatively to high crude prices. while the threshold for crude prices is higher for US markets, given the fact that it has large domestic production and parts of local economy built around oil & gas businesses. Indian markets can be volatile into and post the annual Union Budget. In the US, the annual Federal Budget is usually a non-event as far as broader markets are concerned. Similarly, the sensitivity of the US markets to Central bank comments may be much higher than what one would see in India. Another thing to note is there are a multitude of data releases that are put out on a monthly and quarterly basis in the US, which are keenly tracked. There may be public (government) and private data releases that influence markets like monthly employment data, home price index, retail sales data etc. Ideally, tracking the three major indices for an entire year and understanding their sensitivities to different variables would provide a good perspective to beginners.

Similarly, there are many differences in how individual stocks react. For example, tech stocks (including the large-caps) and high-growth stocks, in the US market tend to be very volatile on quarterly earnings – up to 10 per cent movement on quarterly results either way is normal. A 10-20 per cent movement on quarterly results is not unusual. Even a 20-40 per cent movement happens occasionally. For example, in February 2016, LinkedIn, which was worth $25 billion then, fell over 40 per cent just within an hour of market open after it gave a revenue outlook for the year that was 7 per cent below consensus expectations. Within a period of just 4 months, this entire loss was made up when Microsoft signed a deal to acquire Linkedin for $26 billion. So, tracking the stocks for an extended period of time across multiple quarterly earnings is essential to understand the nuances of how stocks react to earnings and also how/whether they recover or not.

Another aspect to know is that it is a widely common practice in Silicon Valley to issue shares with differential voting rights. However, unlike in India where Tata Motors DVR trades at a substantial discount to higher voting rights shares, in the US there is hardly much of a discount in cases where both category of shares are listed and, in some instances, the lower voting rights shares trade at mild premium as sometimes only those shares are included in multiple indices/ETFs due to higher liquidity.

2 Knowing the data sources

It is very important that your research and analysis starts with right, quality of data. A good starting point for that would be the primary sources of data – company filings.

If you want to invest in US stocks, the most important documents that one should study to learn about US companies are the 10-K and 10-Q filings.

The 10-K is an annual filing by listed companies and is more comprehensive than the usual annual reports. Besides complete details on financials and related aspects, the document contains details on business of the company, key competitors, key customers (customers representing more than 10 per cent of revenue), segment data (geographic and business segments) etc. Using a 10-K statement one can build the supply chain impact for a specific company from results of suppliers or make inferences from results of customers/competitors even before the specific company has reported results. For example, investors/analysts try to make calls on Apple results/ new product launches based on results/data from a component supplier/s for iPhone.

A 10-Q is a filing based on quarterly results. It provides key details on quarterly results and is more comprehensive than the quarterly filings of India companies. For example, 10-Q filings give balance sheet and cash flow statements every quarter vs quarterly filings of Indian companies that in many cases disclose only P&L data. This will enable an investors to assess how well the cash flows are tracking the quarterly profits reported and determine the earnings quality.

A few other important filings are:

Form S1 – the IPO filing similar to red-herring prospectus of Indian companies. .

Form 8-K – a filing that companies need to make whenever there is a materially significant event like M&A (Mergers and Acquisitions), change in CEO/CFO, significant changes in ownership etc.

Form 14-A is filed when shareholder vote is required to complete a transaction like M&A. This would include details of the M&A, background and other offers received, rationale as to why the deal would be beneficial etc.

Form 13-F – A quarterly report filed by institutional investment managers on their equity holdings.

This can be used to check what the big investors found as interesting investments.

All these documents will be available on company websites in the Investor Relations section and the SEC (Securities and Exchange Commission) website under company filings.

3Analysing the stocks

Once you get a hang of the ways of the market and know how to look up for information on individual companies, then the approach to stock-picking is somewhat on familiar lines.

For knowing the various sectors in the market one can start with a popular classification used by professional managers -- the Global Industry Classification Standards (GICS) developed by MSCI and S&P.

It is a classification of listed companies into 11 broad sectors. One can start with the S&P 500 companies with their GICS clusters (can be got with a Google search) and sub-group them into smaller sub-sectors/clusters based on their similarities.

This can be done based on data in 10-Ks that explain the business of the company, its key competitors, end-markets/ customers etc. It would help analyse and understand companies within their peer group and how companies in a sub-sector react to the same set of news flow.

This apart, understanding the financials of companies, the key valuation metrics and following their quarterly earnings and conference calls will also enhance the learning curve.

For example, for tech companies in the US, one of the most important metrics to evaluate their valuation is based on Enterprise Value (EV)/Free Cash Flows, EV/adjusted EBIT or adjusted EBITDA and Price/Sales.

Enterprise value is usually considered as many tech companies are net cash positive and considering EV would give a better total value the market is assigning for the company.

Similarly, adjusted EBIT/EBITDA is considered because many growth companies have high stock-based compensation expenses that impact their net profits negatively and adjusted EBIT/ EBITDA would provide a better perspective on the operational strength of the business and what would be the sustainable profit once early-stage expenses recede.

4 Enhancing your research

Finally, to up your game, here are some third party websites and news sources to refer to.

Yahoo Finance: One of the best websites to track stocks listed in the US is Yahoo Finance. Besides offering a convenient way to track stocks with real-time quotes, create and monitor portfolio, get news alerts on stocks etc., it offers key data that is not easy to get unless you are an institutional investor or individual investors with deep pockets – forward consensus estimates. It is an accepted fact that markets look to the future.

Hence, no fundamental analysis can be complete without some idea on forward expectations. While Yahoo Finance only gives 1-year forward consensus revenue and EPS data, it is useful vs having no forward estimates at all. Getting more details of analyst estimates and for multiple years would require subscription to premium services like Bloomberg Terminal or S&P Capital IQ, which are exorbitantly expensive . Most of Yahoo Finance features are free and they offer a few other analytical tools and insights for a premium subscription.

SeekingAlpha: This is an insightful crowd sourced content service to get research and opinions on US stocks. While any crowd sourced content comes with its flaws as anyone can give an opinion there, ultimately the wheat gets separated from the chaff as those with good research content and opinions will end up with better following and ratings. So, investors must manoeuvre through this to identify the right experts. The site has many current and former professional institutional investors, fund managers, analysts and amateurs giving insights on stocks and macro economy. Some of the content is free and some has subscription charges.

News Sources: Important news sites that one must visit everyday/frequently and read to understand about stock markets, economy/understanding interaction between macro variables etc. are Wall Street Journal (www.wsj.com), Barrons ( www.barrons.com ), Bloomberg ( www.bloomberg.com ), CNBC ( www.cnbc.com/?region=usa ).

WSJ, Barrons and Bloomberg require a subscription. CNBC has most of its content including many videos from their new channel available free, with subscription required for some premium content. Besides, there are news sources that are good for different sectors. For example, if one wants to track the tech sector, then Recode-Vox ( www.vox .com/recode ) is an important site.