Rounding Up the Best Ways to Prepare for the CFA Exam

Use these 8 articles on preparing for the last month before the CFA exam to get everything in order

There’s just six weeks to the June 2016 CFA exam and candidates are feverishly preparing their last month study plans. One of the biggest pitfalls that catch CFA candidates is all this time meta-studying, or studying about studying. All the time you spend finding resources, asking other candidates and putting together your study plan is time you could be spending on the curriculum and getting those last few points you need to earn the CFA designation.

To help speed up the task of meta-studying  and build out your last month study plan, we highlight the best articles on preparing for the CFA exam as well as checklists you can use to make sure you’re on track. Use the articles below as your guide to plan out your CFA study schedule as well as prepare for the big day.

Best CFA Advice on Studying

This last month CFA study plan includes the tools and resources you’ll want to use to get through the material one last time before the exam. You won’t be able to read the curriculum again but these resources will help you cover as much as possible to make sure you’ve mastered the topic areas. The article also includes a strategy on how to use practice tests to guide your study plan to focus your time where it’s needed most. Includes a six-day study schedule that you can customize with your available time.

A big hurdle to effective studying is the uncertainty around whether you’ve studied enough. Candidates freak out and scramble for ideas and input on how much is enough and what more they can do. I put together this CFA study checklist to help you know that you’re on the right track or to point out some milestones you need to reach for confidence on the exam. How many times do you need to read the curriculum and other sources? How many practice problems should you do?

The last week before the CFA exam was always my favorite. In this last week CFA schedule, I talk about how to use the time as a study-vacation and how to get the most from your time. The post also includes exam day materials and a link to some important Institute pages.

Best CFA Advice on Preparing for the Big Day

This CFA exam day checklist includes everything you need to prepare for the big day. You’ll find links to a review of the typical exam day, a list of testing centers and the CFA testing center policy. This is information directly from the CFA Institute so make sure you know it.

This post on 10 ways to relax on CFA exam day has been one of our most popular this year. The chemicals released when you’re nervous won’t help you remember the curriculum or pass the exam. One of the best things you can do to get a passing score is just to relax and have the confidence that you’ve done all you could…and that it will be enough. There’s ten great ideas here so definitely a few for everyone.

Most people carry an emergency road kit in their car but do you have your CFA exam day emergency kit ready? The post includes a list of things you’ll want to put together to have on exam day. The list includes required exam materials like your passport, admission ticket, pencils and calculator. It also includes the just-in-case materials that can mean the difference between passing the exam or ending up in one of the fail bands.

This is your CFA exam day strategy, a replay of the big day starting with the night before and running all the way through the afternoon. You’ll get advice on what to eat for breakfast and important considerations for getting to the exam. I cover what happens as the exam starts and how to spend your lunch to relax and set yourself up for a successful afternoon session.

What to do after the exam isn’t something candidates usually think about but you’ll want to check out this post-CFA exam checklist. It will get you started on making next year’s exam a success by setting an email reminder and reflecting on what worked for this year’s study plan.

The important idea here is to get what you need to put your last month study plan together and then get back to studying. Don’t spend time preparing to study at the expense of actual studying and the points you need to pass the CFA exam.

‘til next time, happy studyin’
Joseph Hogue, CFA


The CFA and a Higher Standard for Wealth Management

The new fiduciary standard for investment advisory won’t surprise CFA charterholders, they’re already using it

The Department of Labor rolled out its final changes to the Fiduciary Rule for financial advisors earlier this month. The new rule isn’t as restrictive as many in the industry had feared but still means a lot of changes for how advisors communicate with clients.

CFA candidates and those with the designation won’t be surprised by the new fiduciary rule and may be instrumental in helping the advisory industry adjust to the new regulation.

The Fiduciary Rule Gets Watered Down

Dodd-Frank legislation in 2010 required a fiduciary rule but it took years to work the proposal through government bureaucracy. The Labor Department withdrew an early plan in 2011 after push-back from the financial services and insurance industry. President Obama called for a new version in 2015 and set the DOL to the task.

A proposal was completed in January, setting off a firestorm of criticism from financial service providers. The U.S. Chamber of Commerce even threatened to sue the federal government on the new rules and the DOL received more than 3,000 comment letters after the proposal, the majority from those in the advisory industry against the changes.

The previous rule for advisors was a suitability standard for investment recommendations. The standard was highly subjective and advisors were free to recommend products with high fees as long as they could rationalize that the investment met their client’s need for return or risk. The new fiduciary rule seeks to require that advisors act in clients’ best interest, which would imply that they recommend lower cost product options when they exist.

From what I have seen of the new rules, most of the change revolves around presenting clients with a best-interest contract explaining the fiduciary rule. I’m critical of how effective this will be in aligning advisor-client interests or whether it will merely be another paper to sign when a client opens an account. A sticking point of the proposed rules was the timing of the contract signature. It was originally proposed that advisors would have to provide a best-interest contract on first interaction with potential clients but this requirement was dropped and the new rule only requires the contract when an advisory account is opened.

The final rules still allow advisors to earn commissions on retirement assets as long as they provide full disclosure to investors. IRA providers can still recommend in-house products without having to sign contracts with investors but the products must still meet best-interest standard.

The new rules will take effect April 2017 but advisors will have until January 2018 to become fully compliant.

CFA Curriculum and the Fiduciary Standard

The CFA Code and Standards has required the fiduciary standard well before the new rule was proposed. The fiduciary standard appears in several places in the Ethics & Standards material, first in the Prudent Investor Rule and then in requirements for Soft Dollar brokerage.

The fiduciary duty shows up first in Standard III: Duties to Clients with “Members and Candidates must determine applicable fiduciary duty and must comply with such duty to persons and interests to whom it is owed.”

The Prudent Investor Rule requires a fiduciary obligation to the client which entails loyalty, impartiality and prudence (care, skill and caution). The CFA Institute requires that clients’ interests should always receive the highest priority in investment research, above the interests of the firm and of the advisor.

In the soft-dollar standards, the investment manager must fulfill their fiduciary duty through three general practices.

  • Seeking to obtain best execution through best value
  • Minimize transaction costs
  • Use brokerage (soft dollars) only for the benefit of the client

The CFA Institute Research Foundation published a literature review around Investment Professionals and Fiduciary Duties in 2014 to aid in the conversation. Now that the new rules have been finalized, CFA candidates and members can be instrumental in helping the industry to understand the requirements and to accept the changes.

‘til next time, happy studyin’
Joseph Hogue, CFA

Don’t forget your Free CFA Mock Exam!

Learn to use mock exams and CFA practice tests to guide your study plan and pass the exams

The CFA mock exams are now available on the CFA Institute website for registered candidates. If you are registered for the June exam, you have access to a free mock exam and topic tests. Both of these can be critical in guiding your study plan over the last two months and getting the most out of your time.

The CFA mock exam is designed to mimic the exam day experience with timed sections and structured along the exam topic weights. The Level 1 and Level 2 CFA mock exams include a morning and afternoon section of multiple choice questions. The Level 3 CFA mock exam does not include a section for the morning essay questions but does test you on the afternoon vignette format. The exams include the correct answers, a brief explanation of each and reference the curriculum on each question.

The CFA Institute recommends you take the mock exam towards the end of your exam preparation and most third-party mock exams take place well into May.  There’s good reason you may want to consider taking your mock exam much earlier than this to get the most from the experience.

How to Get the Most of Your CFA Mock Exam

I always thought it was odd that CFA mock exams were not held until mid-May at most local societies or third-party providers. I remember taking one mock exam on the 18th of May, just over two weeks before the June exam.

At this point, what is the mock exam going to do for you? You’ve got little time to rearrange your study plan. If you do poorly on the mock exam at this late in the game, it makes for a very stressful few weeks before the actual exam.

Getting the most out of your CFA mock exam means doing it early and in an environment that will simulate the actual test.

Ask your local society to organize a mock exam day in April or as soon as possible. It shouldn’t take weeks of planning, just reach out to candidates by email to see how many are interested and reserve a room at the library that can accommodate the group. Ask candidates to print off their mock exams and bring them to the event.

If your society cannot hold a mock exam day, you can still simulate the exam day experience by going to a semi-quiet public place. It shouldn’t be completely quiet like a solitary room but some place like the library with ambient noise.

Testing yourself in this exam day-type environment is going to test your concentration. If you find it difficult to concentrate on the exam with background noise, you’ll know to take earplugs to the actual exam in June. Testing yourself on three-hour sections will also help you see how your mental and physical stamina holds up. If you find yourself getting tired before time runs out, you should consider exercising ahead of the exam with more three-hour testing sessions.

More than anything, taking the CFA mock exam early is going to help you focus your study plan. It’s one thing to remember answers when taking short topic tests on material you’ve just studied that week. It’s another thing entirely to remember answers to all 18 study sessions all at once.

While taking the mock exam, you might want to mark the number on questions where you are unsure of the answer. This will help you review the questions that you happen to guess correctly but might need more study in the topic. Review the answers to these and any incorrect answers after the exam. Once you’re done, you’ll have an idea of how well prepared you are in each topic area. You can use this to rearrange your study plan over the last month to focus on those areas in which you need more work.

Don’t Just take One CFA Mock Exam

Also available and free to registered CFA candidates is a series of shorter topic tests. Download these from the CFA Institute website and use them for more practice.

Mock and practice exams are hugely beneficial and you should try doing more than one. Six hours is a long time to put pencil to paper and you need to train your body to not get tired. Without training over at least a few mock exams, you may not even realize how tired you’re getting and how much it’s affecting your score.

Taking multiple mock exams is also a great way to fine-tune your studying. Your first few months of studying were all about getting through the curriculum and touching on everything. Your last few weeks of studying should be about making sure you have a good understanding of everything but also making sure you get every last point where it counts.

I would recommend doing at least one mock exam every two weeks and a three-hour exam every other weekend. Try doing these in a semi-public place to get used to the noise and testing environment. You can use question banks to randomize the questions or take them in topic-order. Do this for the last month or few weeks leading up to the exam and you’ll be more confident and prepared for June.

‘til next time, happy studyin’
Joseph Hogue, CFA

10 Ways to Relax on CFA Exam Day

Learn how to relax on CFA exam day to help unlock everything you’ve worked so hard to learn

OK, so it’s nine weeks left to the CFA exams and the last thing you want to think about is exam day. You want to hear all the secrets to getting every last point and how to master the material, right?

We’ve covered study strategies, the ins-and-outs of each exam and just about every part of the curriculum on the blog. The one thing we have never covered in more than four years of the Finquiz blog may be one of the most important to your success on the CFA exams…how to relax on exam day!

CFA exam day is stressful (that should be STRESSFUL!). You’ve studied for 3+ months and upwards of 300 hours for this one day and you know that nearly half the candidates will have to repeat the same exam next year. The hormones released when we experience stress, cortisol, affects your ability to recall from your memory…and your chances for success on the CFA exam.

Now before you start getting stressed out about stress on exam day, check out these ways to relax and get the confidence you need to pass.

10 Ways to Relax for the CFA Exam

1) Put it into perspective. One year within a lifetime career isn’t really that big of a deal. I know you want to pass all three exams in three years but relax, it’s not that important. Focus on learning the material and being a better professional, exam success will follow. Think about that on exam day.

2) Meditate for five minutes. Find a quite spot at the testing center, you might have to go somewhere nearby, and just sit with your eyes closed for five minutes. Breathe deeply and relax. Know that you have done all you can and it will be enough.

3) Concentrated breathing. Concentrate on your breathing for a few breathes. Breathe deeply in and out and feel yourself relaxing with each exhale. It’s amazing how just slowing your mind and breathing can help calm you down.

4) Take some chocolate squares. Dark chocolate has ingredients that regulate the stress hormone cortisol.

5) Chew some gum. This one never really worked well for me but I’ve heard it work for other people to reduce stress.

5) Green tea contains L-Theanine, a chemical that is supposed to relieve anger and calm you down.

6) Visualize success. Close your eyes and visualize the day for five minutes. See yourself sitting down to the exam and smiling. See yourself working through the questions, still smiling because it’s easier than you expected. See yourself and a huge sigh of relief as you walk out of the test center knowing that you passed the exam.

7) Try a little cold water. Dripping cold water on your wrists and behind your ears can help calm you down by cooling the major arteries just beneath the skin in these spots.

8) Make a checklist. For me, organization is calming. Making a checklist of things I need to take with me or of things I need to study/do to pass the exam helps me to know that I’ve covered everything.

9) Stretch for five minutes. Doing some light stretching helps to relieve muscle tension and aids circulation. Start with your toes and work your way up to your neck.

10) Take a walk. It will be early morning before the CFA exam starts so hopefully it won’t be too noisy outside. Try walking a few blocks in one direction from the test center. Breathe the fresh air and enjoy the morning a little.

Everything else aside, I always found the best way to reduce stress on exam day was super-preparation. Cover the material multiple times from multiple sources, i.e. reading the curriculum and study notes, working practice problems and flash cards, etcetera. The more you study, the more confident you are going to be going into the exam. It may not be the easiest answer but it will get you the designation.

‘til next time, happy studyin’
Joseph Hogue, CFA

10 Week CFA Study Plans for Every Type of Candidate

Two 10 week CFA study plans for candidates that haven’t started and for those with a head start

We’ve got 10 weeks left to the 2016 June CFA exams and this point always seems to be a milestone for candidates. Maybe it’s just that ten is such an easy, round number that cause people to reevaluate their CFA study plans or motivate others to finally get started.

I get emails from both types of candidates. Those that started months ago want to make sure they’re on the right track. They start thinking about what they can do to change up their study plan to avoid burnout and squeeze out those last points they need to pass the exams. The candidates that haven’t managed to get started yet finally get nervous enough to crack open the books but are worried they don’t have enough time to study.

I thought I would use this week’s blog post to share some ideas for 10 week CFA study plans, one for those that have been studying and one for those just getting started. You don’t necessarily need to change up your plans if you already have a good routine but take a look at some of the ideas below.

10 Week CFA Study Plan for Candidates with a Head Start

If you’re already well into your CFA studying then revising your plan now is all about constantly testing where you’re at and changing your study plan to fill in the gaps.

We reviewed the Finquiz CFA question bank a few weeks ago and how to use it to test your progress across study sessions. You should be doing practice problems when you finish every reading and then doing more a day or two afterwards to refresh what you learned. Consider taking a half test or at least 90 questions every weekend to test your retention across all 18 study sessions. This is going to help you see where you need more studying.

If you haven’t read through all the readings yet, finish the remaining material up first. After that, go back and spend some more time on the core topic areas (those with the most points on the exam like FSA) and those readings where you are not scoring as well on practice tests.

You don’t need to read the CFA curriculum as thoroughly as you did on your first pass. Scan the official readings for the key points while using study guide notes to reinforce the Learning Outcome Statements. For your review, try to get through at least two study sessions a week.

10 Week CFA Study Plan for Candidates Just Starting

If you haven’t started studying for the CFA exam yet, or only have a couple of weeks of studying done, you’ve got a lot of work ahead of you. That 300 hours studying that the average candidate spends ahead of the CFA exam is now like a full-time job spread over 10 weeks.

There is still a chance though if you devote yourself fully to the task. If you can make studying for the CFA your job, studying eight hours a day throughout the week, you can get the necessary studying in with no problem. If you have to do your studying after work or on the weekends, it is going to be more difficult but still doable.

The difference with this 10 week CFA study plan compared to the one above is that you don’t have as much time to read through the official curriculum. The CFA curriculum is the best resource for studying but it’s just way too long when you’re pressed for time.

If you are to save the last week for an intensive review, you’ll need to work through two study sessions each week just to finish all of them. Instead of reading through the curriculum then study notes, try reading through the study notes first. This will give you a good idea of the important points and will make the curriculum reading faster and you’ll pick out those key points more easily.

Split your week into two 3-day study sessions, each one to cover one of the 18 study sessions in the curriculum. Read through the study notes and the curriculum over the first two days then spend the third day doing practice problems and reviewing the study notes one more time. Three days isn’t much to cover each study session but you’ll get through the entire curriculum in nine weeks.

One of the most important ideas for this accelerated CFA study plan is to use your time efficiently. You absolutely must study in a place where there will be no distractions. Turn off your cell phone and disable the internet browsing on your computer. You need to study straight through and cannot afford to spend your time doing anything else. If you can reserve a private study room at the library, that’s usually your best option but any quiet and uninterrupted space will work.

Whichever study plan you follow, you’ll still want to take the last week off from work for studying if possible. I always loved my last week before the CFA exams, studying upwards of ten hours to get those last points before the exam. It’s a challenging week but well worth it when you go to the exam confident that you’ll pass.

‘til next time, happy studyin’
Joseph Hogue, CFA

Does the CFA Make you a Better Investor?

While the CFA may not guarantee you earn higher returns, I believe it can make you a better investor

One of the most common questions I get asked by friends and family is if the CFA curriculum or having the charter makes you a better investor. To this question, I think the answer is yes but it’s really not the question they are asking. Most people outside the profession really mean, “Does the CFA mean you will earn higher returns?” Of course the answer to this one is no.

It might seem like semantics and you might question whether the two questions are really different. They are different and I think it’s a difference that CFA candidates need to understand about themselves and how they answer the question.

How the CFA will Make you a Better Investor

There’s no doubt that many CFA charterholders have been able to provide amazing returns for their clients. Among the charterholders I follow are Bill Gross, Abby Joseph Cohen and the near-legendary Bill Miller who’s Legg Mason Value Trust Fund beat the S&P 500 for 15 consecutive years to 2005.

But all of these charterholders have had their off-years and have under-performed their index at some point. While the long-term return on the assets they manage may be higher or lower than a benchmark, it’s not really the most important advantage they bring to their clients.

Their advantage is in how the CFA curriculum and experience has shaped them as an investor.

First, as a CFA candidate, you see much more than the narrow view that most analysts and asset managers see through their career. Most will never expose their world to the breadth of topics and investments you’ll see in the CFA curriculum. You may not need to calculate the options-adjusted spread or use Treasury options in your client’s portfolios but you have the tools to do so.

Think of two repair technicians that come out for a service call. One has a small tool box with a hammer and a couple of screwdrivers. The other has a truck filled with just about every tool imaginable, some which you don’t even know the name. The second technician is the CFA charterholder and he’s prepared for anything.

Beyond this breadth of knowledge across the curriculum topic areas, the CFA gives you a holistic view of investing and how the pieces fit together. Over the three CFA exams, you progress from the stock market basics of each topic area to working through your own solutions using what you’ve learned.

Just the process of earning the CFA charter forces you to push yourself and understand the importance of study. I’ve seen too many analysts and managers fall into a routine of doing their job but never really studying the new topics in the industry or brushing up on their skills. This leaves them dangerously behind in a very competitive industry. CFA charterholders know the value of continuing education and the Research Institute helps keep you at the front of changes in the industry.

Focusing on how the CFA curriculum may or may not make you a better investor, it’s easy to overlook the advantage you’ll get in being among some of the most critical-thinking and professional people in the business. CFA charterholders have worked hard to develop their skills and their careers and they benefit from a community that shares that hard work with its members. Learn how to tap your fellow charterholders and candidates for more than just a work reference but to exchange ideas and insight.

My opinion that the CFA experience will make you a better investor doesn’t end the debate and there’s still room for argument around charterholder returns versus those earned by other managers. I have yet to meet a CFA charterholder that felt the experience wasn’t worth it or that it didn’t make them a smarter investor or money manager.

Just 11 weeks to the June exams. Stick with it and be better for it!

‘til next time, happy studyin’
Joseph Hogue, CFA

Where to Look for CFA Jobs

While the CFA designation won’t guarantee you a job, it will make it easier to get your foot in the door

It’s always around this time of year that CFA candidates start wondering if all the work and all the studying is really worth it. The number of emails in my inbox asking if the CFA will help land a job in asset management increases and candidates lose focus on the exams.

First, don’t lose focus on your study plan and why you are taking the CFA exams. There’s just 11 crucial weeks left to the 2016 CFA exams and you’ll need every minute.

We all know that the CFA won’t guarantee you a job but it will make finding one and getting interviews easier. Beyond the jobs that require progress on the CFA, I’ve seen first-hand the benefit of having the designation when applying for positions.

Understand where to look for CFA jobs and some alternative ideas to quickly find the best opportunities.

Where to Look for CFA Jobs

The website eFinancialCareers crunched the numbers on 90,000+ resumes uploaded to their platform in 2014 and found some interesting facts on CFA jobs. More than 26% of the people looking for jobs in asset management had “CFA” listed on their resume. Other sectors of finance with a high amount of resumes featuring the term “CFA” were equities (25%), fixed-income (21%), research (21%), hedge funds (20%), M&A (17%), private banking (13%), and risk management (13%). It’s important to note that these included candidate resumes as well as charterholders and that this wasn’t necessarily hiring managers but job candidates within a sector.

The CFA Institute provides its own breakdown of where its nearly 124,000 charterholders are working with portfolio managers (22% of charterholders) claiming the overwhelming majority, followed by research analyst (15%), C-level executive (7%), consultant (6%), corporate financial analyst (5%), financial advisor (5%), risk manager (5%) and relationship manager (5%).

cfa jobs for candidates

Where you look for CFA jobs will largely be determined by how far you’re willing to move for the right opportunity. If you’re only looking for jobs close to where you currently live, then your first stop should be the job boards of the companies in your area.

Go through a list of all the CFA charterholders in your local society to see where they are employed then visit the job board of each. Make a note of any contacts you know at the company as well as the charterholders that work there.

While you can use other internet sites to find local CFA job opportunities, the real benefit is in the ability to search globally for jobs. The CFA Institute Jobline is your first stop for global jobs requiring the CFA designation or candidacy. There are more than 2,030 jobs open from 155 employers and in just about every corner of the world. The search function on the site is fairly robust with the ability to search by keyword, country, region, category and type of job.

Beyond the Institute’s jobline, I’ve always found good listings on as well but you’ll have to weed through more bogus jobs than on professional job boards. Set up an email alert for a few keywords like investment analyst, financial analyst and equity research.

Non-traditional Jobs for CFA Candidates

Beyond the traditional career path for CFA candidates, a lot of opportunities are opening up in freelancing and alternative finance. We highlighted the growing market for crowdfunding and peer lending analysts in a recent series of posts. The demand for analysts could boom as these forms of alternative finance become more mainstream and develop secondary markets. Being ready for the opportunities may mean being proactive enough to develop your own analysis framework or model to value investments in the two areas.

Freelancing analysis opportunities are increasing along with the internet age and companies’ need to cut costs wherever possible. You may need to work on building some practical skills if you haven’t any formal experience in financial modeling but this is fairly easy to do in a few months. Beyond equity analysis, I’ve found freelance jobs in consulting, whitepaper reports and general market commentary.

There’s no singular path through the perfect career and few careers are linear at the same employer or in the same sector of finance. You might start out freelancing but find you want to leverage it into a traditional job or after working in a traditional setting, you might decide you want the freedom of freelancing. Put together a picture of what you want to do and the career path to your dream job but be flexible.

‘til next time, happy studyin’
Joseph Hogue, CFA

Warren Buffett Sounds the Alarm on Accounting Shenanigans

Warren Buffett’s comments on earnings quality is something the CFA Institute has been teaching for years

Warren Buffett recently released his annual letter to shareholders (downloadable here) and used the event to highlight a huge problem in financial reporting. As he asked investors to overlook a portion of GAAP amortization costs that depressed Berkshire profits, Buffett warned that he was hesitant to join a practice that is too common in financial reporting.

“But it is with some trepidation that I do that, knowing that it has become common for managers to tell their owners to ignore certain expense items that are too real.” (page 16)

Promoting non-GAAP results has become commonplace to smooth fluctuations from one-time items like write-downs, restructuring and pension fund contributions. The problem is that the practice may be getting out of hand. More than half the companies in the S&P 500 beat earnings estimates in the most recent quarter while more than half missed revenue expectations…that suggests some financial shenanigans and analysts need to take notice.

How Companies Trick Investors with Questionable Earnings Quality

Buffett calls out stock-based compensation as the “most egregious example” of earnings adjustments arguing that removing this as an expense is ridiculous. He’s right. I’ve always marveled at the audacity of management that’s tried to convince investors that this form of compensation is anything but an expense. While it may be a non-cash expense, it still has a significant effect on ownership and earnings.

Aswath Damodaran posted an excellent review of how companies, particularly Twitter, are inflating their adjusted EBITDA by adding back stock-based compensation. The company added back $521 million in compensation to arrive at adjusted (Non-GAAP) net income, helping Twitter to post a profit for the quarter. Stock-based compensation is not an ‘extraordinary’ expense, especially for fast-growing tech firms like Twitter.

Buffett doesn’t let analysts off the hook and says they, “often play their part in this charade, too, parroting the phony, compensation-ignoring “earnings” figures fed them by management.” Whether the analysts don’t know any better or don’t want to lose access to management, Buffett says they are “guilty of propagating misleading numbers that can deceive investors.”

Buffett also says investors should suspect the rationale of adding back depreciation charges to arrive at an EBITDA measure of profitability. For capital intensive companies, the mismatch between large capital investment and the depreciation charge leads to even GAAP earnings being higher than true economic earnings.

While EBITDA is supposed to provide a clean view of the company’s earnings power, it is here that a lot of manipulation occurs and you should do your own adjusting to find a company’s true EBITDA. Vice Chairman of Berkshire Hathaway and Buffett friend Charlie Munger has himself said that, “every time you see the word EBITDA, you should substitute the word ‘bullshit’ earnings.”

Analysts at Bank of America/Merrill Lynch sounded the alarm earlier this year as well. BofA found that 90% of companies are now reporting “adjusted” earnings, up from just 70% in 2010. Besides the need to constantly reach for more transparency in earnings, the trend may be an immediate threat as well. GAAP earnings have been negative for three of the last four quarters though “adjusting” earnings might be holding up investor sentiment artificially. Analysts need to see through the manipulation and present the case factually to investors or the whole house of cards may come crashing down very soon.

The CFA curriculum has included measures of earnings quality and income statement manipulation for years. Make sure you pay attention to the material on accounting shenanigans and the aggregate accruals formulas in the Level 2 CFA curriculum. Also, pay attention to the calculation of economic profit and how it differs from other earnings measures. Don’t be complicit in management’s game and give your clients the transparency they deserve.

‘til next time, happy analysis!
Joseph Hogue, CFA

CFA Candidates have an Advantage, and it’s Not the Designation

It’s not necessarily the designation that gives CFA candidates the advantage over their finance peers, it may be something far deeper

We’re just 14 weeks to the 2016 CFA exams and candidates are laser-focused on one thing; passing the CFA and earning those three little letters. They think the designation proves their worth to employers and to an industry where cyclical restructuring is commonplace.

Don’t get me wrong, having the CFA designation has helped me get a lot of freelance analyst jobs. I’ve gotten my foot in the door to more places than I would have otherwise, including spots on Bloomberg and consulting at venture capital firms, and I think my work on the CFA exams had a lot to do with it.

But it’s not the designation itself that helped me get all those things and it’s not your true advantage as a CFA candidate. It was my WORK on the CFA exams and what it represents.

CFA Candidates Work Hard for their Employer and their Clients

I don’t know about you but I worked hard to pass the three CFA exams and earn the designation, harder than I ever worked on two undergraduate degrees and a Masters’ degree. I’m not sure the 300 hours usually quoted as the study time it takes to pass an exam is even accurate. Besides the hundreds of hours studying, CFA candidates sacrifice their personal lives to be a better investment professional. It’s long weekends and empty libraries for three years or more just for the chance to break into an industry where you’ll be expected to work even harder.

CFA candidates have a get-it-done mentality. That’s not something you develop suddenly but something you have that is uncovered by the trials of the CFA exams. Employers see the CFA designation as a crucible that has weeded out weak job candidates before human resources has to do it.

CFA Candidates are Able to Change along with the Industry

Possibly more important than the hard-working spirit that the CFA exams show in candidates is what it says about the candidate’s ability to stay ahead of an industry that’s constantly in motion. Layoffs have been announced by nearly every mega-cap bank with Bank of America’s 16,000 dwarfed by the 50,000 planned layoffs at HSBC. The last few years are no different and these types of massive changes are only increasing as technological change takes hold of the industry.

Every segment of the financial industry is constantly in flux. An analyst that can’t stay one step ahead of others will fall behind. An asset manager that cannot innovate and evolve will see his clients jump to another firm.

CFA candidates are proactive, one of the most sought characteristics within finance. Nobody is forcing you into one of the toughest professional designations in finance. You signed up for the exams and pour over the curriculum on your own because you know it has to be done.

While the CFA designation or being a CFA candidate may bring these traits out, it’s your job to keep the momentum going after the exams. You’ll work hard in your role as analyst and asset manager, what will set you apart is your ability to push yourself even harder and keep using those characteristics that came out during the CFA exams.

The continuing education program by the CFA Institute isn’t mandatory but you should consider it as such. Take an hour or two every week to think on what you are doing for your clients and what else you can do, and learn.

As you finish the CFA exams and earn that designation, don’t forget what it really means.

‘til next time, happy studyin’
Joseph Hogue, CFA

FinQuiz CFA Question Bank Review

Use this CFA question bank review to guide you through the process of using the FinQuiz question bank

I’ve gotten a lot of questions from CFA candidates about the FinQuiz suite of study materials so I thought I would try out the question bank software. It’s been almost five years since I took a test around CFA questions but I felt confident my score wouldn’t be too bad (hopefully). I’ve kept up-to-date on the curriculum through the blog and use most of the material in my job as an equity analyst.

I got access to the CFA question bank in the FinQuiz dashboard. The first page is a filter screen where you choose which readings you’d like to test. You can also filter the questions by ones you haven’t attempted, those answered incorrectly before or bookmarked questions. You can select to score as you go, randomize the questions and select how many of the 2,345 questions you see.

Starting the Question Bank Test

The testing page shows a timer at the top along with the Learning Outcome Statements (LOS) from which the specific questions are coming. Candidates studying for the CFA exams should pay attention to the timer and keep themselves to a timed-experience to better prepare for the exam.

The questions are very similar in structure to what you’ll see on the CFA Level 1 exam. Each question is two to four sentences long including data and sometimes a data table. Three potential answers are given and provided in a multiple choice format. If you chose, score as you go, you will see the correct answer after making your selection.

You can bookmark and write notes to each question for better reviewing when you finish the test. This is helpful for marking which questions had you stumped or other notes to track your progress. Each question also includes a feedback box for sending comments or notes to FinQuiz.

CFA Question Bank Results

I did pretty well, scoring 90% on the 30 CFA Level 1 questions though I had to think about quite a few and the time ran longer than I expected. It has been quite a while since taking a test on the Level 1 curriculum but I use the material quite a bit.

The reports to track your CFA question bank performance are really helpful. Immediately after finishing the test, you see a screen summarizing your question bank results. The screen lists each question with an ID, your selected answer and the correct answer if you made an incorrect choice. You see from which readings the questions came so you can review those where you might need more work.

CFA Test Bank FinquizYou can review all the questions, those you scored correctly or incorrectly and those you bookmarked. The software gives you the option of retaking or deleting the test.

Clicking back to the dashboard shows your cumulative performance across each study session and all the question bank exams. This is a great way to track your progress studying for the CFA exam because you’ll know in which study sessions you need to review.

cfa test resultsOver 2,000 questions means you’re not likely to run out of questions and can work the question bank into your regular studying. After reading the curriculum for each study session, do the end-of-chapter questions. The next day, review the FinQuiz curriculum notes and do another 30 questions from the question bank. The following week, review the study session with another 30 question exam to make sure you retained the material.

This study routine should give you a pretty good idea of which study sessions you need to spend some more time reviewing at the end of 18 weeks. Take a few full-length practice exams using the question bank to retest the entire material. Aim for at least 75% on each study session and you may want to aim for 80% or better on the core material like Ethics, FSA and Equity.

‘til next time, happy studyin’
Joseph Hogue, CFA

CFA Level 1 Curriculum Review: Financial Statement Analysis

Reading 28 in the CFA curriculum combines the financial statements with key ratios and analysis

This is the fifth week of our CFA Level 1 review of the financial statement material. Reading 28 is your first look into the financial statement analysis and techniques that will make up a big portion of your CFA level 2 exam. In all, financial reporting and analysis accounts for 20% of your level 1 points and up to 20% of the second exam.

Check out the introduction to CFA Level 1 Financial Statements
Check out the CFA Level 1 Income Statement Review
Check out the CFA Level 1 Balance Sheet Review
Check out the CFA Level 1 Statement of Cash Flows Review

Some of the ratios and financial analysis techniques you’ll see in reading 28 have already been discussed in the separate readings on each financial statement. Besides specific techniques used in analysis, pay attention to assumptions used in different techniques and the limitations of each method.

Ratios and Common-Size Financial Statement Analysis

Ratios in financial statement analysis offer a way to standardize information and compare results across companies. It can be used to compare current results with past performance as well. Ratio analysis is limited across companies because each might operate in a slightly different product category or market. Differences in accounting practices can distort ratios and there’s no definite set of ratios that will tell you all you need about a company.

Activity ratios measure management efficiency in day-to-day operations. I’ve included some of the most common ratios used below. Activity ratios are also called asset utilization ratios. Notice that when you use Balance Sheet data in a ratio with another financial statement, you need to take the average of the beginning and ending number reported on the Balance Sheet.

cfa activity ratiosSolvency ratios measure the firm’s ability to meet long-term obligations. Liquidity ratios measure the firm’s ability to meet short-term obligations. Pay attention to the Cash Conversion Cycle which reflects the number of days a company’s cash is tied up in the operating cycle. The conversion cycle equals the number of days inventory plus days receivable outstanding minus the number of days accounts payable outstanding.

Understand the difference between operating leverage and financial leverage. Operating leverage comes from using fixed costs in the company’s business and magnifies the effect of sales growth on operating income. Financial leverage comes from the use of debt and magnifies the effect of changes in EBIT on net income.

cfa debt and liquidity ratiosProfitability ratios measure overall performance and margins. Gross, operating and net margin are used often to show different ideas of profitability.

cfa profitability ratiosIt may seem like a lot of ratios to memorize but they are fairly easy to remember after some repetition. Write the ratios and a brief explanation on some flash cards and review them each day until you’ve mastered the concept.

Common-size financial statement analysis is helpful in spotting trends within a company’s results as well as comparing accounting line items across firms. A horizontal common-size statement compares an accounting item like sales or operating expenses against itself from another year. It’s helpful in finding growth across time in each line item. A vertical common-size statement compares an accounting item against another line in the same year, usually against sales or total assets. It’s helpful in comparing the proportion of a line item in one company against another.

For common-size analysis on the balance sheet, you’ll use total assets as the common item. For analysis on the income statement, sales are used as the common item for comparison.

There’s quite a bit more in reading 28 including DuPont Analysis and some important ratios for equity analysis. All the ratios in the reading could easily show up on the CFA exam since they’re pretty easy to test in a quick question. The best way to approach the material is to understand the concept of the ratio. Instead of just rote memorization of the equation, understand what the components are and how they relate to each other. You’ll find it much easier to remember the mountain of ratios and equations for the exam.

‘til next time, happy studyin’
Joseph Hogue, CFA

How to Prepare for Jobs in the New Financial Revolution

This marks the final article in our series on the alternative finance market and the potential for huge change in analyst demand in the future. Alternative finance through crowdfunding and peer lending is changing the way companies get funded and the way people apply for loans. The World Bank expects the $30 billion alt-finance market to reach $90 billion by 2020 and many other estimates expect even faster growth.

Being able to take advantage of this growth as an investment analyst or asset manager means preparing your skills to be in demand for the new revolution in finance. Analysis of crowdfunding deals and peer lending shares similarities with traditional financial analysis but there will also be aspects that will be totally new. Not only will the new market need analysts for securitization and initial deal valuation but asset managers and teams will be needed for the secondary trading market when it develops.

Check out How Crowdfunding and P2P Lending will Change Wall Street
Learn How to Analyze Crowdfunding Opportunities
Learn How to Analyze Peer Lending Opportunities

Preparing for Alternative Finance Opportunities with the CFA Curriculum

Several of the sections within the CFA curriculum will give you a good start on analyzing alternative finance opportunities. For analysis of equity crowdfunding, you’ll need a mastery of financial reporting and analysis as well as insight into private company valuation. Pay attention to the section on quality of financial reporting and how to spot financial shenanigans. You’ll need to see through the accounting tricks and income statement manipulation to understand the true financial health of a startup company.

Understanding investment appropriateness and asset allocation will be important when talking with clients about alternative finance opportunities, especially when talking about investing in personal loans and other alt-type loans. Equity crowdfunding returns are likely to be very similar to venture capital, meaning most deals will fail with only a few providing a return.

The CFA curriculum around fixed income investments will be the most closely related to peer lending analysis. Understand that most peer loans are for shorter durations and won’t be at risk for downgrades.

Real estate crowdfunding has been one of the biggest beneficiaries of the boom in alternative financing. Developers are finding a much easier funding source compared to traditional bank or institutional financing. I’ve talked to several developers that have started their own crowdfunding portal just to fund in-house deals. There isn’t as much in the CFA curriculum around real estate development as there is for other investment analysis but look to some of the material on private equity valuation to get you started.

Making your Name as an Alternative Finance Analyst

The huge demand for analysts in the alternative finance space could just as easily start online and as a freelance market as it could a traditional market at institutional firms. Peer lending and crowdfunding are an evolution of traditional finance into the social space so it would make sense that analyst demand could start from online as well.

There is already some demand for analysts and asset managers on the institutional level but the real growth will come from the retail investors. Right now, there is limited need for ongoing analysis because of the lack of a secondary market for crowdfunding equity and peer loans. Once secondary market trading really gets going, we’ll see huge growth in analyst demand.

Besides a mastery of topics within the CFA curriculum, there are a few other things you can do to put yourself at the top of the list for this analyst demand.

Unless you’ve got prior experience valuing venture capital or startup deals, you may want to work with a few experienced analysts to learn the basics. Connect with a few investors on the equity crowdfunding sites to find out how the analyze deals and see if you can help out by putting together a report. Get the financial statements from a company seeking equity crowdfunding.

  • Convert the financial statements into common-size statements, calculate financial ratios and analyze the proforma estimates.
  • Analyze the market for the company’s product, sales potential and risks
  • Build a valuation model around your financial statement analysis and through comparison with competitors

You may have to create a report or two on your own and without getting paid but you’ll be able to use these reports to pitch potential employers or clients. A simple website is easy to put together and can help showcase your analysis to investor-clients. Start early enough and you’ll have built a reputation for great analysis by the time the demand for analysts and asset managers really starts to ramp up.

‘til next time, happy analysis!
Joseph Hogue, CFA

CFA 2016 Review: Level I Statement of Cash Flows

This is the fourth week of our CFA Level 1 review of the financial statement material. We look at the Statement of Cash Flows this week, a statement that shows the inflows and outflows of cash over the period. Actual cash flow is much harder to manipulate compared to the income statement so analysts use this statement heavily in their work. Make the Statement of Cash Flows your new best friend.

Check out the introduction to CFA Level 1 Financial Statements

Check out the CFA Level 1 Income Statement Review

Check out the CFA Level 1 Balance Sheet Review

Understanding the Statement of Cash Flows

Like the Income Statement, the Statement of Cash Flows shows activity over the period. Remember, this is different from the Balance Sheet which shows assets, liabilities and equity only at one point in time. To compare Cash Flow numbers with Balance Sheet data, you’ll need to take an average of the beginning and ending balance sheet number for an appropriate comparison.

Understand also that cash flow is not the same as net income. Income is an accounting idea based on revenue earned and matched expenses but may not mean the company is generating cash.

A company’s cash flows are separated into one of three sections; operating, investing and financing.

Cash Flow from Operations is the cash generated from normal day-to-day operations. Throughout the cash flow statement, it will be important to distinguish between inflows and outflows of cash. Cash inflows for operations include: collection on sales and accounts receivable, receipt of interest or dividends. Cash outflows for operations include: payments to suppliers and accounts payable, payments to employees, interest payments and payment of income taxes.

Cash Flow from Investing Activities is the purchase or sale of long-term assets, assets like PP&E or long-term investments that will help generate sales for years to come. Cash inflows for investing include sales of non-current assets. Cash outflows here include the purchase of non-current assets.

Cash Flow from Finance is the borrowing and repayment of debt, issuing stock or paying dividends. Cash inflows include issuing stock or bonds. Cash outflows include paying debt or dividends and buying back shares.

The Statement of Cash Flows is connected to the balance sheet through cash. The sum of the three cash sections on the statement, plus the beginning balance of cash from the balance sheet will equal the ending cash balance for the end of the period.

cfa level 1 review statement of cash flows formatYou are going to be spending a lot of your time working through cash flow statements as a new analyst. The Statement of Cash Flows can be constructed from information given on the other two financial statements. The best way to understand the statement, and a must-know topic for the CFA exams, is mastering the two methods for calculating and reporting the statement: the Direct and Indirect methods.

I’m not going to write out the methods here. It’s something you need to write out and study in detail and both methods are shown in the curriculum and in the Finquiz Notes. It can seem tedious to practice through the methods but you need to do it to learn how the statement is constructed through cash changes. Practice with real company financial statements to see if you come out with the same numbers.

Cash Flow Analysis

Performance ratios used with the Statement of Cash Flows include: cash flow to sales, cash return to assets or equity, and cash flow per share. These are all pretty easy to remember and not nearly as important as two other concepts in the reading.

Other than a basic understanding of the cash flow statement, the most important section in the reading is on Free Cash Flow to the Firm (FCFF) and Free Cash Flow to Equity (FCFE). You will use these two concepts throughout the curriculum and absolutely must master them.

Free Cash Flow to the Firm (FCFF) is the cash flow available to all capital providers (debt and equity) and equals:

Net income + Net noncash Charges (depreciation and amortization) – Investment in working capital – Investment in Fixed capital + after tax interest expense

The calculation for FCFE is fairly easy but you need to make sure not to get the components confused with FCFF. FCFE is CFO minus investments in fixed capital plus net borrowing, or the cash flow available to common equity holders without placing a burden on operations.

FCFE can be more volatile than other cash flow measures because of the capital expenditures spending, so you might have to use a multi-year average if the test question mentions it. Though you will probably not be asked to do so on the test, some analysts adjust CFA for nonrecurring expenses before calculating FCFE. A big focus in the CFA curriculum is conservative practices, almost always favored when a choice is given. Adjusting items for non-recurring events and taking the average of volatile accounts over a period of time are more conservative and provide a more stable estimate.

Make sure you can go from FCFF to FCFE or can get there from multiple routes. Thinking through the various accounts and why they are included will help get these concepts down. PRACTICE, PRACTICE, PRACTICE.

FCFF = CFO + interest(1-tax rate) – Fixed Capital Investment

FCFF = EBITDA(1-tax rate)+depreciation expense(tax rate) + (increase in deferred tax) – (investments in fixed and working capital)

FCFE = FCFF – interest(1-tax rate) + net borrowing

Most CFA candidates haven’t had as much experience with the Statement of Cash Flows or haven’t taken time to really master the direct and indirect method so spend some time on the reading to really understand the statement.

‘til next time, happy studyin’
Joseph Hogue, CFA

How to Analyzing Peer Lending Opportunities

Peer lending and alternative finance offers a new world of opportunities for investment analysts but you need to know key criteria

While crowdfunding has dominated the media attention with stories like the Coolest Cooler and Oculus Rift, it’s peer lending that accounts for the majority of funding volumes. P2P loans on sites like Lending Club and Prosper reached $25 billion in 2015, 73% of the total alt-finance space.

We looked at the amazing growth in alternative finance and how it’s changing Wall Street in a prior post. With rates at historic lows and bonds paying next to nothing after inflation, peer lending investments are offering investors the chance to diversify their fixed-income portfolio and earn a higher return.

Even on the huge growth in peer lending, the $25 billion in loans is still a fraction of the total loan market. I studied just how big peer lending credit could become on my blog PeerFinance101 and found the current P2P market just 0.15% of the total $16.3 trillion loan market.

While institutional investors are already training their analysts to evaluate peer lending investments, the retail market may offer a huge opportunity to freelance analysts as well.

What is Peer Lending Investing?

Peer lending and P2P investing is really very similar to the traditional way loans have been originated and sold to investors. In the old model, a bank originates a loan and then sells its portfolio to a broker or investment firm. The broker then sells chunks of the package to investors according to different criteria like maturity and borrower risk.

P2P investing is the evolution of this model into the social space online. Borrowers apply for their business or personal loan on platforms like Lending Club. The platform checks the borrower’s credit, assigns a rating and an interest rate on the loan. Investors can then invest directly in the loan, usually from $25 and up on each loan. The platform collects monthly payments on the loan which include principal and interest and passes the money on to investors.

Peer loans are generally unsecured personal loans or small business loans and are quite a bit riskier compared to traditional fixed-income debt. Loans are usually offered on 3- to 5-year terms at a fixed rate. Borrowers pay a 5% origination fee and most sites charge investors a 1% annual fee.

Returns for investors have been very good, ranging from 5% to almost 10% for loans after accounting for defaults.

peer loan returns

Despite the fact that p2p loans are unsecured, average credit scores for most borrowers are actually pretty good. Lending Club and Prosper only loan to borrowers with credit scores of 680 or higher (prime loans) while some sites originate loans to borrowers with a 640 credit score or higher.

Institutional investors and even banks have started to invest heavily in peer loans as a way to diversify fixed-income portfolios and provide for higher returns. Banks have also found a way to remain active in the credit market without the heavy lending regulations imposed by the government. This institutional interest is creating demand for analysts that can rate and analyze personal loans and other p2p investments.

The size and dispersion in the retail market means the demand for analysts is still fairly new but growing as well. Since individual investors don’t typically have a large chunk of their portfolio in peer loans, fees to p2p analysts would not be very large to manage single accounts. This will change as more investors put money in peer lending and firms can build larger, dedicated departments of analysts.

How to Analyze Peer Lending Investments

There are no formal rating agencies for peer loans though each lending platform employs its own methodology for assigning a rating and an interest rate. This may change eventually as the market grows and investors look for a more consistent source for ratings.

The peer lending platforms make it fairly easy to pick loans for retail investors, offering dozens of criteria on which to search loans. Some of the criteria will not mean much in creating excess returns but there are some factors that tend to result in lower defaults and higher returns. I talked to a peer lending investor last year that has averaged a 12% return over the last six years and made $10,000 on his portfolio of loans.

Within my own portfolio, I like to focus on loans with the following criteria:

  • No credit inquiries in the last six months
  • Home Ownership
  • Debt to Income ratio of less than 20%
  • Income greater than $55,000 per year
  • Protected borrower occupation, someone working in education or public service is less likely to lose their job

The major peer lending platforms make all their loan data available so it would be relatively easy to create your own proprietary model for analysis, whether you built it yourself or outsourced the model. The model would allow you to pick certain criteria from the list and then back-test returns accordingly. You could then sell the model to investment firms or use it as a freelance analyst for peer lending investors.

It may take a few years of growth but the peer lending industry will eventually be a strong source of demand for financial analysts. Secondary markets where investors can buy and sell loans have just been launched, adding to the analysis need beyond the origination market. Learn how to analyze peer loans early to distinguish yourself in the market.

‘til next time, happy investing!
Joseph Hogue, CFA

CFA 2016 Review: Level I Balance Sheet

Master this introductory material on the balance sheet in the 2016 CFA Level 1 curriculum to breeze through tougher concepts later

This is our third week of reviewing the CFA Level 1 Financial Statement material, following the introductory reading and income statement analysis last week.

We begin on our review of the Balance Sheet, reading 26 of the CFA Level 1 curriculum, this week. The balance sheet is not quite as talked about among investors as the income statement but is no less important. Understand how the balance sheet relates to the other two statements, especially how assets are depreciated and expensed.

Understanding the Balance Sheet

The Balance Sheet financial statement is different from the other statements in that it is a snapshot in time rather than a presentation of activity over the period. The Balance Sheet shows assets, liabilities and owner’s equity as of the last day in the reporting period.

Assets represent economic resources of the company, resources that can be used to generate cash or sales. Liabilities are current or future obligations of the company, representing an outflow of economic benefit. Owner’s equity represents the remaining assets or economic resources after all creditors (liabilities) are paid. This gives rise to the balancing of the Balance Sheet with Assets equaling liabilities and equity.

Assets and liabilities are presented in terms of liquidity. Assets that are highly liquid like cash or those that can be converted to cash are show first. Those liabilities that are expected to be paid within a year are shown first in short-term liabilities. The remaining assets and liabilities are shown in long-term accounts because they are expected to be used or paid out over more than a year.

cfa level 1 review balance sheetUnderstand that some of the assets on the Balance Sheet will have a contra-asset and the difference between historical value and net. Accounts receivable is offset by the allowance for doubtful accounts for Net Receivables. Property, Plant and Equipment is offset by depreciation for its net value.

There is a lot of accounting concepts on the balance sheet but you must know them to be a good analyst. You’ll go into more detail on how inventories, long-term assets and other accounts are depreciated, expensed and recorded in other readings. If you don’t have a strong background in accounting, it’s imperative that you spend the time necessary to master this introductory material so you can understand the more detailed readings.

The differences between U.S. GAAP and IFRS reporting can be tedious and confusing. It’s best if you put together a table for each financial statement. Label the different accounting items (inventory, PP&E, etc) down the left-side column followed by columns for GAAP and IFRS. This makes for a quick review of the differences that you can use a few times a day until you’ve got them committed to memory.

An important distinction on the Balance Sheet is the classification of financial assets. Financial assets (liquid assets in stocks and other securities) are either classified as Held-to-Maturity, Held-for-Trading, or Available-for-Sale. How the asset is classified will affect how it’s value is recorded and how the gains/losses show through to the income statement.

  • Held-to-Maturity assets are measured at amortised or historical costs and no unrealized gains/losses are reported.
  • Held-for-Trading assets are recorded at fair value and marked to market with unrealized gains/losses recognized as profit/loss on the income statement and in retained earnings.
  • Available-for-Sale assets are recorded at fair value with unrealized gain/loss recognized on Other Comprehensive Income and accumulated within owner’s equity.

Balance Sheet Analysis

As with the reading on the Income Statement, the analysis here is fairly light with just some ratios. The reading is focused more on the accounting concepts for the Balance Sheet while other readings will go deeper into the analysis.

In ratio analysis, you must remember to adjust your Balance Sheet numbers when using them with numbers from the other financial statements. It’s easier than it sounds, you just need to take the average of the beginning and ending values for the Balance Sheet number.

For example, the Days Sales Outstanding ratio is found by taking the average of the beginning and ending receivables on the balance sheet and then dividing by sales or credit sales from the income statement.

Make sure you understand and remember the liquidity ratios and the solvency ratios. These are very basic and will be used throughout the CFA exams and your job as an analyst.

Liquidity Ratios: Current, Quick (acid-test), Cash
Solvency Ratios: Long-term Debt to Equity, Debt to Equity, Financial Leverage

We’ll continue with the Statement of Cash Flows next week and then a week for financial statement analysis. Make sure you are scheduling enough study time to read through the curriculum, work practice problems and then review study notes. It’s only this repetitive system of studying that will allow you to commit the material to memory.

‘til next time, happy studyin’
Joseph Hogue, CFA

How to Analyze Crowdfunding Opportunities

We started our look last week into how alternative finance is changing Wall Street and how CFA candidates can prepare to meet the need for a new kind of analyst. This week, we take a closer look at one side of the alternative finance theme. While peer lending brings in more money each year, equity crowdfunding is doubling the amount raised annually and could be ready to surge higher.

The Securities & Exchange Commission (SEC) finally approved rules last year that allow any investor to participate in equity crowdfunding. Until the rules go into effect in May, only accredited investors with more than $1 million in wealth can participate. Opening the door to non-accredited investors opens equity crowdfunding up to 58 million households in the United States alone.

analyzing equity crowdfunding cfaThat means the potential for billions more in small business funding to equity crowdfunding campaigns. Until now, the industry has placed it on the individual investors to do their own analysis. It’s assumed that accredited investors understand the risks and have advisors to help them analyze deals.

This won’t be the case when non-accredited investors enter the equity crowdfunding arena and we could see a surge in demand for analysts. Crowdfunding platforms may hire their own team of analysts to provide support while independent analyst firms will be created to serve the need of tens of millions of new investors.

What is Equity Crowdfunding?

It’s important to make the distinction here between rewards-based and equity crowdfunding. In rewards-based crowdfunding, business owners and social projects give away products or ‘rewards’ to supporters of the project. Donors receive these gifts but get no ownership in the company. In equity crowdfunding, business owners sell an ownership percentage in the company to investors much like they do in an initial public offering.

In fact, equity crowdfunding is simply offering shares publicly without going through an investment bank and the stock exchanges. Business owners complete a registration process with the SEC and provide proforma financial statements on the crowdfunding platforms, then reach out through the internet to attract investment directly from individual investors.

I’ve covered equity crowdfunding on my blog Crowd101 for some time and believe it could be the next big thing for investors. While investment risk is high, non-accredited investors have never had this kind of access to startup firms. Equity crowdfunding offers the potential for very attractive returns similar to venture capital and angel investing, previously only open to wealthy investors.

Consider Peter Thiel’s $500,000 investment in Facebook in 2004. By the time the company went public in 2012, the investment was worth $1.7 billion for an annualized 176% return over eight years!

Of course, not all early stage investments pay off nearly as well as Facebook or even at all. Research by Willamette University showed that more than half (55%) of angel investments end up returning less than the original investment while only about 10% produce returns of five-times the investment or higher.

The risk and return involved in equity crowdfunding has the potential to create a massive market for analysts, both traditional and home-based. The virtual nature and size of most equity crowdfunding deals may mean the industry lends itself better to freelance analysts that can work remotely. Besides the need for analysts on the investor side of the table, companies seeking equity crowdfunding will need help putting together proforma financial statements. Since these companies will be much smaller than typical venture cap targets, they’ll likely need to contract with freelance analysts to develop their statements rather than bring on full-time workers beyond their accounting staff.

How to Analyze Equity Crowdfunding Deals

Analyzing equity crowdfunding deals is very similar to venture capital and startup analysis. Companies are typically nano-cap or even smaller with less than $1 million in annual revenue.

Your biggest challenge as an analyst for equity crowdfunding deals will be to check management’s assumptions on the proforma income statement. Management will provide estimates for market growth and the amount of market share the company can achieve over the next three to five years.

  • How much competition is there for the product? How might existing competitors react to a new startup?
  • How fast does management think it can increase sales and market share each year? It might be fairly easy to enter the market but competitors may start fighting if the company takes more than a percent or two of share.
  • Are sales expectations realistic given general economic trends and industry growth?

Expense estimates will need to be carefully scrutinized, especially estimates for marketing costs. New companies will need to spend quite a bit on advertising and then increase costs relative to sales growth. Compared to established publicly-traded firms, startups may have higher Selling, General & Administrative costs because they haven’t yet reached efficiency and economies of scale.

Expenses for professional fees should closely analyzed. Startups with small management teams will need to hire out many professional tasks but it also lends itself to related-party transactions and fraud. Make sure management is not funneling money to friends or relatives through professional services when the same services could be provided more inexpensively in the market.

Keep an eye on management perks and travel expenses as well. Management should be compensated for its effort but should not be using the company as a piggy bank for a lavish lifestyle.

One of the biggest differences for equity analysts of later-stage companies is the accounting and analysis for net operating losses and the carry-forward of up to seven years. In my experience as a director of equity analysts, most are not well-prepared to handle the accounting for net losses. Make sure you understand how losses affect taxes and how the carry-forward works on financial statements.

Besides equity crowdfunding companies that will be smaller than those supported through venture capital deals, the companies’ management team may be less experienced and formalized. One of your tasks as an analyst will be to gauge management’s experience and ability to handle growth as projected on the proforma statement. Does management already have outside expertise through other investors that will be providing assistance or is management open to allowing an outside group to provide assistance?

One of the biggest benefits to venture or angel funding for a startup is this outside expertise. If a crowdfunding startup is not open to allowing this kind of assistance, it will need to prove its ability to meet projects otherwise.

There is also a social aspect to analyzing equity crowdfunding deals. Crowdfunding supporters and investors typically feel a higher level of buy-in with the companies they support and may provide a strong base of marketing and sales for the new venture.

  • How well has management used social media and how active is the company’s social network?
  • Did the company pre-launch its equity crowdfunding deal, evidenced by a high amount of funding in the first few days of the crowdfunding campaign?
  • What percentage of sales are projected to be local to the company and how active is it in the local community?

The equity crowdfunding space is still evolving and we are likely to see more campaigns for debt (peer lending) and royalty share of profits before the equity-side of the space really takes off. We’ll cover analysis of peer lending and the opportunities for p2p analysts next week.

Joseph Hogue, CFA

CFA 2016 Review: Level I Income Statements

We started our review of the CFA level 1 financial statement material last week with a basic understanding of the financial statements and the framework in analysis. A lot of this introductory material is extremely basic but you should resist the urge to speed through it. Financial Statement Analysis accounts for up to 20% of the points on all three CFA exams and you will need to use it every day during your career as an equity analyst. Most importantly, you’ll need most of this introductory material to understand more detailed concepts and formulas on the CFA Level 2 and Level 3 exams.

We jump right into it this week with a look at the income statement, the major accounting concepts and statement analysis. The income statement is likely the most talked about in the financial press of the three principal financial statements though you’ll spend just as much time as an analyst on the other two statements. We’ll be using the Finquiz notes to the CFA curriculum.

Understanding the Income Statement on CFA Level 1

The income statement represents the company’s profitability over a period of time, either a quarter or through the year. Analysts use the income statement to evaluate the quality of a company’s earnings and earnings growth rate.

CFA income statement structureIncome statements have a fairly basic layout that starts with sales or revenue and then deducts expenses, taxes, interest and other items to arrive at net income.

You should remember the requirements for revenue recognition under IFRS and U.S. GAAP. The general rules plus recognition of special cases like long-term contracts is highly testable material, especially quick calculations like the percentage-of-sales methodology.

Income from operations is an important number because it shows the operational earnings power of the firm. The operating margin, operating profits divided by sales, can be used to judge the operational efficiency of the company compared to competitors. Operating earnings are sometimes referred to as Earnings Before Interest and Taxes (EBIT) and an important valuation multiple will be on EBITDA, which adds back depreciation and amortization.

Everything below net income from operations is referred to as “below the line” and includes many items that are not part of normal operational activities. The definition and reasons why an activity is reported below the line as non-operating items is very important. Understand the difference between Extraordinary Items (not allowed under IFRS) and Unusual or Infrequent Items.

  • Extraordinary Items are both infrequent and unusual, such as losses on natural disasters and expropriations.
  • Unusual or Infrequent Items are either/or and are generally reported as part of continuing operations of a company. Common items are restructuring charges or gains/losses on sales of an asset.

CFA inventory costing methodsExpense recognition around inventory will be very important material so master the LIFO, FIFO and weighted-average costing methods. You’ll see whole readings on this later so getting the basics here will make the more detailed readings easier to grasp. An important point is the effect of different costing methodology on Cost of Goods Sold.

Understand how to calculate Weighted Average Number of Shares Outstanding over a period as well as the difference between a simple and complex capital structure. Understand the difference between basic EPS and diluted EPS along with which securities are used in the calculation of dilution (i.e. options, warrants, convertible debt, convertible preferreds).

CFA Level 1 Income Statement Analysis

The focus on the CFA level 1 exam is placed on understanding the layout and accounting of the income statement rather than detailed analysis. The analysis in Reading 25 is fairly basic and just covers common-size statements and margins.

Common-size financial statements are a way of comparing statement items against a major line item like sales or assets. In vertical common-size analysis, you find the percentage of each line item relative to sales for each year. This is helpful in seeing if particular expenses have become larger or smaller in significance. In horizontal common-size analysis, you base each line item off of itself in a common year. It helps to see changes in expenses over the years.

Three margin ratios are common in income statement analysis,

  • Gross margin is the percentage of revenue after cost of sales and may help show different competitive strategies across companies
  • Operating margin is the percentage of revenue after operating expenses and is valuable in showing how well management controls costs
  • Net margin is income divided by sales and shows the overall income statement profitability

This basic statement analysis is detailed further in Reading 28 of the CFA level 1 curriculum which brings the financial statements together for a closer look at analysis and ratios. These are some of the most important readings you’ll cover within the curriculum and for your job as an analyst so make sure you spend as much time as it takes to master the material.

‘til next time, happy studyin’
Joseph Hogue, CFA

How Crowdfunding and P2P Lending will Change Wall Street

Crowdfunding and peer lending are quickly becoming mainstream finance and could change the CFA and Wall Street forever

Small business community Manta ran a survey last year and found that 67% of business owners felt they didn’t have enough small business funding choices. Worse still, more than two-thirds (69%) felt the funding environment had not improved or was worse over the last year.

There’s no mystery why funding for small- and medium-size enterprises (SMEs) has dried up. Regulatory requirements around Basel III and Dodd-Frank have increased lending costs and capital requirements for traditional lenders. Because of costs to make small business loans which are considered riskier, it costs just as much to make million dollar loans as it does to make a $50,000 loan.

It’s destroyed the profit motive to make loans of under $250,000 and left many business owners with no options. A 2014 survey by the Federal Reserve found that less than half of small business loan applications are approved.

Alternative Finance Becomes Mainstream

Enter crowdfunding and peer lending as alternative funding sources. The social finance phenomenon has been growing for years but banks are just starting to take notice. The group surpassed $30 billion in funding last year, topping venture capital funding for the first time, and has doubled each year since 2012.

crowdfunding-2016-estimateThe demand for peer loans has surged and accounts for over 70% of funding. There is actually surprisingly little different between peer lending online and the traditional bank approach. Instead of bundling and selling off their loan book to borrowers, banks have been cut out of the picture by p2p platforms like Lending Club that connects borrowers directly with investors.

Beyond the increased regulatory costs on traditional financing, peer lending platforms have another competitive advantage over banks. According to Foundation Capital, branch office costs account for more than 30% of a bank’s total operational spending and there’s a physical limit to the number of applications that loan officers can review. By reducing the physical overhead costs, peer lenders can generate cost advantages of 4% in loan origination compared to the old model of finance.

The crowdfunding industry may be a smaller part of the financial revolution but could see even stronger growth over the coming years. The Securities & Exchange Commission (SEC) finally approved regulations to allow non-accredited investors to participate in equity crowdfunding, a move that will open up crowdfunding investment to more than 58 million households in the United States alone.

The crowdfunding model has bifurcated into two worlds. In rewards-based crowdfunding, businesses and social causes raise money and give out products or services in exchange for donations. Supporters receive no ownership stake in the business.

In equity crowdfunding, business owners sell an ownership share in the company to investors. The process is similar to issuing public shares except businesses go straight to the public instead of through an investment bank.

There’s an oft-overlooked benefit to crowdfunding, both equity- and rewards-based. Supporters and investors feel a strong level of buy-in with the businesses because they feel like they helped make projects possible. Crowdfunding offers a huge opportunity for small business owners in social marketing and customer loyalty.

How Alternative Finance will Change Wall Street and the CFA

The investment opportunity in peer lending and crowdfunding hasn’t come soon enough for investors. Even as the Fed tries to end its historic low-rate program, interest rates remain stubbornly low. The yield on A-rated corporate debt is just 2.17% for the five-year maturity. Legendary investor Jack Bogle recently forecast annual returns of just 6% for stocks and 3% for bonds over the next decade.

Compare that abysmal outlook to returns of over 8.4% for loans issued on the Lending Club platform between 2013 and 2014, after adjusting for defaults. Crowdfunding returns are similar to those found in venture capital and other early-stage investments.

peer loan returnsThe lack of a liquid secondary market for peer loans and the fairly small size of the crowdfunding market means there hasn’t been much of a demand for analysts in the space. This will surely change over the coming years as the market expands and equity crowdfunding opens to the investing public.

The problem is that traditionally trained analysts may not be ready for the idiosyncracies of the alternative finance market. Within peer lending, analysts will need to integrate human factors into credit models as well as estimate a liquidity premium for the market. Analyzing crowdfunding deals will be similar to analysis of venture capital deals but will also need to include other social factors.

Here at Finquiz, we want to lead this monumental shift in finance. Over the next month, we will be posting several articles examining how to analyze investments in peer lending and crowdfunding. We’ll look at the CFA curriculum and how it can help candidates prepare for the coming wave of demand for alt-finance analysts. We’ll also look at what you can do to prepare for opportunities in this new analyst market.

Joseph Hogue, CFA

CFA Level 1 Review: Understanding Financial Statements

Don’t neglect this basic information on financial statements in the CFA curriculum

One of the most important topic areas in the CFA curriculum is Financial Statement Analysis, which accounts for upwards of 20% of each exam’s points. Reading 22 of the CFA Level 1 curriculum is your first step into the world of financial statement analysis and a critical skill you’ll need during your career.

I thought it would be helpful to point out some of the highlights of the Finquiz Study Notes on the reading and some other tips to the Level 1 CFA material within financial statement analysis. Over the next few weeks, we’ll cover the other key topic areas and readings in the CFA level 1 exam to help you get the most points possible.

An Introduction to Financial Statement Analysis

The Finquiz study notes for Reading 22 is eight pages long and covers all the learning outcome statements for the material. Rather than a substitute for the curriculum, Finquiz notes are meant to complement your reading of the CFA curriculum to make sure you cover all the material and reinforce the most important points.

The overview section on financial statements and supplementary information is a brief outline of purpose for the financial statements and other information you’ll need to research as an analyst.

Balance Sheet – a snapshot of the company’s financial position at one moment in time. The ‘snapshot’ idea is important because the other financial statements show activity over the entire period. Since the balance sheet differs in presentation, you’ll need to adjust the numbers when comparing against the other statements, i.e. taking an average of the beginning and ending balance sheet amounts.

The balance sheet categorizes everything broadly into assets, liabilities and owners’ equity. Within assets and liabilities, the items are also categorized by short-term and long-term in terms of liquidity.

The Income Statement is the financial results of a company over the quarterly or annual period. Revenues and expenses are recorded according to accrual accounting principles meaning they are matched appropriately though may not reflect actual cash activity.

Your first task will be to understand the difference between items that go in normal operating expenses and those that appear below because they are unusual or infrequent. You’ll also need to understand the general layout of the income statement and ratios like gross margin, operating margin and net margin.

While the income statement is popular with investors, you’ll spend much of your time on the Statement of Cash Flows as an analyst. The statement is an accounting of the actual cash flows of the business over the period. Since it represents actual cash flows, it is less easily manipulated by management compared to the income statement so a very valuable tool for analysis.

Cash flows are separated into three categories:

  • Operating cash flows are generated from normal day-to-day business operations
  • Cash flows from investing are attributed to the company’s long-term investing and disposal of assets
  • Cash flows from financing are attributed to the company’s use and sources of capital like debt and returning cash to shareholders

The Statement of Changes in Owners’ Equity is not quite as important as the other financial statements but you will still need a basic understanding of the components and how it relates to the other statements. Components of the statement include: paid-in capital, retained earnings, minority interests and other comprehensive income.

Beyond these four statements, you will also need to remember what supplementary information can be found in the financial statement footnotes and the Management Discussion & Analysis. These supplementary schedules and items are not as important as the financial statements but you’ll need to know what they include.

You won’t use the Auditor’s Report for much of anything but need to know the layout of the report as well as the difference between the four types of opinion.

  • Unqualified opinion – indicates that the financial statements appear to be free of material misstatements and are prepared in accordance with accounting principles
  • Qualified opinion – indicates some exceptions to accounting standards and perhaps some concerns about the company
  • Adverse opinion – indicates material misstatements and problems in the presentation according to accounting principles
  • Disclaimer of opinion – is given when an auditor is unable to issue an opinion

CFA Level 1 Review: Financial Statement Analysis Framework

The steps in the analysis framework are not as important as the process itself. Working through the readings on each financial statement will give you a good idea of the process. You might want to briefly look over each of the six steps in the process but it is unlikely that you’ll be tested on knowing the name of a specific step.

  • Articulate purpose and context of the analysis – why are you performing the analysis?
  • Collect input data – from financial statements and other sources
  • Process data – adjusting financial statements, ratios and comparing data on common-size
  • Analyze and interpret – produce analytical results
  • Develop and communicate conclusions
  • Follow-up

You’ll go into much more detail on the financial statements and FSA further into the curriculum. Some of this introductory material may seem overly simplified and unnecessary. If you have significant accounting or analysis experience, you can probably skim through it quickly but I would warn against skipping it entirely. The CFA curriculum is very well constructed to be a progressive learning process. Learning the basics in these introductory chapters will make subsequent chapters easier to understand. Skipping the seemingly easy stuff risks missing out on something you will need to know later in the curriculum.

‘til next time, happy studyin’
Joseph Hogue, CFA

Your 2016 CFA Study Plan and How to Get the Most Points

With just under 21 weeks left to the 2016 CFA exams, now is a great time to get started on your 2016 CFA study plan. What? You don’t have a study plan?!?

Don’t worry, a smart study plan to pass the CFA exam doesn’t have to be a complicated or stressful plan. In fact, start now and follow the plan below and it could be a rather relaxed experience. With nearly five months left to study, you can dedicate each week to a study session and will still have time for topic reviews and those all-important mock exams.

Other candidates will tell you to wait a few weeks, that you’ve got plenty of time before you need to start your 2016 CFA study plan. Don’t believe them! Start now and be one of the candidates that pass the exams!

A Timeline for your 2016 CFA Study Plan

The timeline for your 2016 CFA study plan is fairly simple. We want to cover each of the 18 study sessions each week over the next eighteen. Covering just one session per week gives you the time to really hit the material multiple times and commit it to memory. Remember, most people need to see something upwards of seven times for it to be committed to long-term memory.

Some CFA study plans will suggest reading the study sessions out of order, whether mixing easy and difficult topics or some other method. I always just read the curriculum books in order but you can read in any order you choose. The order of the books does a good job of building up to the more difficult material so you have the knowledge to tackle more complex ideas when you get to them. Make sure you read the topic readings in order.

Every six weeks, you should take a 180-question exam on the sessions you’ve covered. This can be done by putting together end-of-chapter questions or more easily with a question bank of practice problems. This is going to help refresh the material and measure your mastery of the curriculum.

Cover each study session in a week and you’ll have nearly three weeks left over before the 2016 CFA exams. You’ll use this time to work mock exams to measure your overall retention and review the most important material. Taking one or two mock exams each week before the actual exams will help you prepare physically for the six-hour tests as well as guide your study plan for areas where you still need work.

How to Study for your 2016 CFA Study Plan

The best study plan combines active and passive learning techniques in repetition. Passive learning involves activities like reading the curriculum or watching a video. It’s an easy way of studying but you don’t retain as much information as you do when you use active learning techniques like working practice problems and flash cards.

The best study plan always starts with reading the CFA curriculum. Resist the temptation to jump straight to condensed notes, they can’t offer all the material and you’ll end up missing some critical points.

After you’ve read through a study session, work the end-of-chapter problems to measure your retention level. Then review study notes on the section to reinforce the key points.

Use a test bank of questions to work another set of practice problems. These are the best resource you can use because they get you actively thinking about the material and mentally ready for the exams.

Review the study session one more time with brief Smart Summary cards of the material and work any difficult concepts on flash cards. You can buy pre-written flash cards but the most effective method is to write your own. You’ll remember more of what you write down yourself and will save money.

Do this cycle for each study session in your 2016 CFA study plan, repeating it each week.

2016 cfa study plan

2016 CFA Study Plan

How long each study session takes will depend on how quickly you read and will vary on some of the more difficult topic areas. You will probably be able to read through Ethics relatively quickly but may need more time on derivatives and other topics. Do not rush through a study session and make sure you hit each step in the cycle.

This 2016 CFA study plan won’t guarantee that you pass the exam in June but it will give you plenty of time to master the material. Covering each study session in multiple formats will help you commit it to memory and you should be able to recall everything on the exam.

‘til next time, happy studyin’
Joseph Hogue, CFA