Matthew Krantz - Investment Banking For Dummies

Investment banking isn’t just a theory or subject. Investment banking isn’t just an economic function, either. Investment banking is a profession that requires the efforts and expertise of armies of trained financial experts. You may have studied English in college, for instance, but you don’t “do” English. But you can practice investment banking (which is something you find out about in Chapter 6). At this point in the book, you go from understanding what investment banking is to how it’s applied in the business world.

Chocolate factories need milk, sugar, and cocoa to produce their delicious products. But the raw materials used by many investment banking firms is the information contained on the financial statements. These documents released by companies provide investment bankers with much of the information they need to start analyzing companies and looking for investment banking opportunities.

But these important documents can’t do you any good if you can’t find them. That’s what you find out how to do in Chapter 6. There you discover tools that make it easy for an expert investment banker to retrieve and find all the relevant data from the financial statements, even information the companies may not realized is as valuable as it is.

Investment bankers in the movies may be best known for roaming the concrete alleys of Wall Street, ears glued to their cellphones, constantly on the hunt for deals. But much of the most important work done by investment bankers is done in front of a computer screen, examining rows of numbers and statistics using spreadsheets and other financial analysis tools. In Chapter 7, you find out how to make sense of all the information that’s contained in financial statements and why these documents are so precious to investment bankers and vital to their success.

Investment bankers know it’s not necessary to read financial statements from cover to cover like a book. Financial statements, like For Dummies books, can be read in sections — you jump to areas that interest you at the time. Additionally, some of the best insights that come from the financial statements result from putting the numbers through the paces by applying financial ratios, which we introduce you to in Chapter 8.

Putting a price tag on companies and other investments is a big part of what investment bankers do. Talk about The Price Is Right on a grand scale! Luckily, you don’t have to play Plinko and guess what companies are worth. There’s no shortage of analysis tools that investors can use to calculate the value of companies. Investment bankers use ratios, such as the price-to-earnings ratio and price-to-book ratio, discussed in Chapter 8, to value companies.

Sometimes, though, the best yardstick of a company’s value isn’t what an investment banker can calculate, but what the market will bear. Understanding how to obtain and analyze past transactions is one way investment bankers can accurately gauge the value that investors will likely put on a company. In Chapter 10, you see how investment bankers handle the process of studying past transactions, and what that means for the value of investments.

Splashy debuts of new companies and their stocks often grab the attention of individual investors. Who can’t resist the success story of an entrepreneur with a dream who brings a company to sell shares to the public for the first time and becomes an instant millionaire? That’s the American way.

But although equity IPOs may get all the attention, much of the heavy lifting of the financial markets is done using fixed-income instruments, also known as debt. Investment bankers are critical cogs in the process of helping companies borrow money at attractive rates in the bond market. You see the role investment bankers play in the bond market and how fixed income fuels the capitalistic system in Chapter 11.

Investment banking is one of those disciplines that you can delve into for decades and still not master. There are corners of investment banking that go well beyond the understanding of the capital markets and even the mechanics of gathering information about companies and their needs for investment to continue to grow.

If you’re willing to put in the time and effort, you can discover very profound ways to understand companies, how they’re valued, and the ways they use financial engineering and investment banking products to maximize their returns.

When it comes to the top skills that serious investment bankers must hone, the discounted cash flow analysis is certainly high on the list. The discounted cash flow is a culmination of many of the tools beginning investment bankers have to create in-depth and comprehensive models of what companies are worth.

The concept of a discounted cash flow may be something you can learn in school. But it’s the assumptions and the quality of the inputs embedded in the analysis that make this technique essential to the investment banker. In many ways, investment bankers can show off everything they know when they create a detailed discounted cash flow analysis, which you find out about in Chapter 12.

Light a stick of dynamite, and you pretty much know what’s going to happen. Bang! But sometimes that explosive power can be used to build as well as to destroy. Explosive power can be used to clear mountains to make way for freeways or tunnels. But dynamite can have some predictable negative uses, too.

In many ways, the use of debt, in a process called leverage, can be much like dynamite. When used prudently, leverage can be a creative force that gives companies the power to grow and create wealth faster than they would have otherwise. But at the same time, leverage can be abused and lead to great destruction of wealth, jobs, and enterprise. The graveyard of companies is littered with examples of businesses that lit the leverage bomb and didn’t know how to harness the power.

In Chapter 13, you see how investment bankers can prudently apply leverage to deals as a way to get very positive results. Success with leverage requires extreme caution, knowledge, and discipline.

Investment bankers often find themselves playing the role of a corporate matchmaker. A big part of the job description is finding new ways to raise money and help companies restructure themselves in a way that makes them more profitable for their owners.

There are many tools companies can use to boost profits, one of which is pushing along M&A deals. Sometimes the investment bankers are contacted by a company eager to sell themselves by looking for so-called strategic alternatives. But other times, the investment bankers are called on by big companies with money to burn looking for a deal. The big companies in the hunt call investment bankers to help identify and court targets.

Investment bankers, in large part, are hired due to their contacts in the business community and their ability to use financial modeling analysis to find deals that make economic sense. In Chapter 14, we explore many of the tools used by investment bankers to identify companies that are ripe for a buyout and discover ways to pair them up with the buyers.