Quest Operation style twist Quest helpline +44 (0)20 7523 8493 [email protected] Nigel Sedgley +44 (0)20 7523 8497 [email protected].

Quest™Operation style twist

Quest™ helpline+44 (0)20 7523 [email protected]

Nigel Sedgley+44 (0)20 7523 [email protected]

24th May 2012

Page 2

Operation style twist: Summary and conclusions

2008-2009 all over again?

There are lots of similarities between events in 2008/9 and recent patterns.

During the 2008/9 trough style performance was volatile but Value ultimately dominated.

The trough in Value in 2008/9 was before the market bottom.

Value rallies tend to be short/sharp events (2-3 quarters) – if you are late, its easy to miss them.

Although the market does not look especially cheap, valuation divergence is high.

Lots of stocks are trading near their trough valuation of the last five years.

The run to safe stocks has left some valuations looking overextended – more than in 2008/9.

During times of profit and cash flow volatility you need to assess Value using stable measures:eg Quest™ market to book, EV/Sales.

Similar Value approach in Nov 08 Quest™ Newsletter delivered strong performance.

Volatility means there will be opportunities. Our screens assess the risk/reward trade off .

History rhymes: Comparing 2007-2009 with 2010-2012

The troughV,Q neutral,Mmtm -ve

Crisis developingValue –ve, Qual +ve, Mmtm +ve

UK Largecap

Now(2010-2012)to 18th May 2012

Then(2007-2009)

Market rallyingValue +ve, Qual neutral, Mmtm -ve

Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials.

Value made an absolute low in Nov 2008, but there was lots of volatility around the trough.

Page 3

Current pattern looks most like Sept 08

60

70

80

90

100

110

120

130

140

J an-10

Mar-10

May-10

J un-10

Aug-10

Oct-10

Dec-10

Feb-11

Apr-11

J un-11

Aug-11

Oct-11

Dec-11

Feb-12

Apr-12

J un-12

Aug-12

Oct-12

Value

Quality

Momentum

Market beating stock-picking tool

Company scores updated daily on

www.canaccordquest.com

Combining Value, Quality and Momentum

Quest™ metrics mixed with conventional data

Style analysis and themes

triAngle Escalator: Who’s moving up and down

Excellent 12- year track record

– 3-pronged approach improves consistency

– UK Large – 42/53 +ve quarters, +4.0% average

– Pan-Euro – 36/48 +ve quarters, +3.0% average

– UK Small – 34/42 +ve quarters, +6.3% average

– North America – 18/35 +ve quarters, -0.3% average

(Value and the Escalator dominate in the US)

Over 12 years of live experience assessing style trends.

UK large cap triAngle performance

Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials

Page 4

100

1000

10000

Aug

-98

Feb

-99

Aug

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FTSE 350

Top quintile

Bottom quintile

100

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Au

g-9

8F

eb

-99

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triAngle™

Value

Quality

Momentum

: What is triAngle?

Equally weighted triAngle is the most consistent, but

there have been a few short/sharp value rallies

: Factors and composition

triAngleValue Quality

Momentum

33% 33%

33%

Page 5

CFROC spread

Capital growth

Equilibrium growth

Fixed charge cover

CFROC change

Quest™ valuation

Quest™ market-to-book

EV/sales rel. LRA

Dividend yield rel. LRA

P/E rel. LRA

9m-relative trend

100/200-day switch

12m-relative range

30/90 day switch

Earnings momentum

Baskets are dynamic: They vary over time depending on what currently represents Value, Quality etc .

CFROC Spread

-30%

-20%

-10%

0%

10%

20%

30%

Feb 99

Aug 99

Feb 00

Aug 00

Feb 01

Aug 01

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Feb 11

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CFROC Spread* FTSE350

Three months ending at date show n*Pre Feb 04 Avg over 5 historic yrs. Post Feb 04 Avg over 4 Historic, 1 Forecast yr.

Value

-30%

-20%

-10%

0%

10%

20%

30%

Feb 99

Aug 99

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Aug 00

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0

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Value FTSE350

Three months ending at date show n

Earnings Momentum

-30%

-20%

-10%

0%

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20%

30%

Feb 99

Aug 99

Feb 00

Aug 00

Feb 01

Aug 01

Feb 02

Aug 02

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Aug 05

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Aug 08

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Aug 09

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Feb 11

Aug 11

Feb 12

0

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EPS momentum 3m FTSE350

Three months ending at date show n

Quality

-30%

-20%

-10%

0%

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30%

Feb 99

Aug 99

Feb 00

Aug 00

Feb 01

Aug 01

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Aug 02

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Aug 04

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Aug 05

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Aug 08

Feb 09

Aug 09

Feb 10

Aug 10

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Aug 11

Feb 12

0

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Quality FTSE350

Three months ending at date show n

Fixed Charge Cover

-30%

-20%

-10%

0%

10%

20%

30%

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Aug 99

Feb 00

Aug 00

Feb 01

Aug 01

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Aug 02

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Aug 04

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Fixed charge Cover* FTSE350

Three months ending at date show n*Live triAngle factor since Feb 04. Previously Ex post backtest. 3m to Feb 04 N/A.

triAngle

-30%

-20%

-10%

0%

10%

20%

30%

Feb 99

Aug 99

Feb 00

Aug 00

Feb 01

Aug 01

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Aug 02

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0

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triAngle FTSE350

Three months ending at date show n

Longer term context: triAngle quarterly backtest

Best for 3 yrs

3rd Best in a decade

9 neg quarters in a row

2nd best in a decade

3rd Worstever

Worst for 3 yrs

Equal weightings dangerous at turning points

Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials.

Quarterly backtests place recent trends in long-term context – Quality has been strong, Value weak.

Value rallies tend to be short/sharp events (2-3 quarters) – 2010/11 saw 9 negative quarters in a row.

Page 6

-40% -30% -20% -10% 0% 10% 20% 30%

triAngle

Value

Quality

Momentum

Quest™ Valn

Quest™ Mkt to Book

EV/Sales rel LRA

Div Yield rel LRA

PE Rel LRA

CFROC Spread*

Capital Growth

Equilibrium growth

Fixed charge Cover

CFROC change

9m relative trend

100/200 day switch

12m relative range

ST Indicator

EPS momentum 3m

UK end Nov 08-end Feb 09: Value rallied before the market

More stable value measures leading the way

Fixed charge cover: Feb-May 2009 -13%, May-Aug 2009 -7%

A sign of rotation

Quality held up

Page 7

80

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160

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09

Apr

09

May

09

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09Ju

l 09

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09

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09

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09

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09

Jan

10F

eb 1

0M

ar 1

0A

pr 1

0M

ay 1

0Ju

n 10

Jul 1

0A

ug 1

0S

ep 1

0O

ct 1

0N

ov 1

0D

ec 1

0Ja

n 11

Feb

11

Mar

11

Apr

11

May

11

Jun

11Ju

l 11

Aug

11

Sep

11

Quest valuation Quest market-to-book Revenue multipleDividend yield P/E ratio

UK Value

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100

120

140

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200

Jan 9

0

Apr

90

Jul 9

0

Oct 90

Jan 9

1

Apr

91

Jul 9

1

Oct 91

Jan 9

2

Apr

92

Jul 92

Oc

t 92

Jan 9

3

Apr

93

Jul 9

3

Oct 93

Jan 9

4

Apr

94

Jul 9

4

Oc

t 9

4 60

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80

90

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120

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160Value (Composite)

P/E

Price/Book

DY

DJSTOXX (RH)

Kept outperforming after the other value measures waned.M&A, just –in-time capexsupport a sustained rally

Which value measures?

2003-6

1992-4Price to book worked well (Pan Euro)

2009-11Market to book headed the Value charge

and sustained performance

Mkt troughMarch ‘09

Mkt peakFeb ‘11

80

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03

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l 03

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eb 0

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ar 0

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pr 0

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ay 0

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n 04

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n 05

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l 05

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eb 0

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ar 0

6

Quest valuation Quest market-to-book Revenue multipleDividend yield P/E ratio

UK Value

During times of profit/cash flow volatility you need to assess Value using stable measures:

eg Quest market to book, EV/Sales.

Page 8

What is Quest™ market to book?

Total market capitalisation (equity + debt + quasi debt)

Quest™ market-to-book = ----------------------------------------------------------------------------

Estimated replacement cost of assets

Quest™ market-to-book

● A variation on Tobin’s Q which compares market value of a company to the replacement cost of assets. (EV/Invested capital)

● Profits, sales, cash flows and dividends are all unpredictable at present.

● Valuation relative to the asset base is more stable.

● Excellent track record at market turning points.(“Time to get into the Q” note – November 2008)

Page 9

Quest default valuation

-50%

0%

50%

100%

150%

200%

May-

01

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Upper qtlMedianLower qtl

Equities Expensive

Equities Cheap

EV/Sales rel. to trailing 10yr avg

0.00

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Upper qtlMedianLower qtl

Equities Expensive

Equities Cheap

Quest Mkt-to-book (ex goodwill)

0.0

0.5

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3.0

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-01

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-11

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Upper qtlMedianLower qtl

Equities Expensive

Equities Cheap

But how much is now priced in?... market valuation charts Median valuation not far off the trough but close to the ‘new normal’

Stock dispersion is high – lots of cheap stocks and expensive stocks look dearer than in 08/09

Corporate action, policy response less likely to be as helpful this time, but less solvency risk

Page 10

Prices as at 9th May

New Normal?

New Normal?

Earnings yield rel. to trailing 10 yr avg

0.0

1.0

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4.0

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-01

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Upper qtlMedianLower qtl

Equities Cheap

Equities Expensive

Quest market to book (yr avg)

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1987

1988

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2011

+12

Current 0.79LRA 0.90

Quest market to book (yr avg)

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

+12

m

Current 0.67LRA 0.80

Quest™ market-to-book: What is the opportunity? Level + dispersion

Europe ex UK smallUK Large capAs at May 24

16% below LRA12% below LRA

Market levelUses average market cap for the year

Dispersion

Page 11

“Time to rejoin the Q”

“Who is still left in the Q?”

“Slowly moving up the Q”

“Jostling about in the Q”

CITN/ Newsletter articles“Time to get into the Q”

As at May 24

There are as many cheap stocks as summer 2009.

Quest™ market-to-book strategies 1) Buy cheapest companies on market-to-book

2) Consider pricing relative to a long-term view of asset’s productive capacity over their lifetime. Take Value AND Quality into account.

3) What if no mean reversion? – need to consider valuation relative to the ‘new normal’

Desire to avoid Value traps: Solvency, asset write downs (badwill)

Quest™ market-to-book

Q-discount (10yr) = ------------------------------------------------------

Cyclical average CFROC / WACC

Quest™ market-to-book

Q-discount (+12m) = ------------------------------------------------------

+12m CFROC / WACC

Page 12

Value screen I: UK Quest™ market-to-book – Time to rejoin the Q?

Updated weekly on Q-files.

Page 13

Our favourite screen which links Valuation with Quality – worked well in 2008

Value screen II: Trough valuations

Stocks trading with 10% of five-year trough valuation on Quest™ market to book

Ranked by

mkt cap

Priced 9th May

A potential source of ideas: Some stocks will be cheap for

a reason. Others will be genuine

opportunities

Screen also available for

EV/sales and other triAngle

metrics

Page 14

Value screen III: Superscreen Criteria

Page 15

Mkt to book below LRA

Quality filters (optional)

triAngle Value score

Upside on Quest and cheaper than usual

15% more upside than 10y average

A broad based value screen using the Quest website screening function

Value screen III: Value supererscreen stocks

Ranked by

mkt cap21 May

AA-B B

>5>0>15Criteria <0.8 Quality

Quality filters.1) Lots of

debt/quasi debt .2) Negative EPS

momentum. Signal of risk of a profit

warning?

Full screen on www.canaccordquest.com

Page 16

Over-extended valuations: The other side of the Value trade

Page 17

Outperformed

Lacks value support

Other risks

Compare with EV/sales

Companies which have outperformed but now lack value support

Over-extended valuations: The other side of the Value trade

Page 18

<13/33>15 >0

21 May

>1 >1

If EV/sales is higher than historic (long-run average), is that justified by higher margins. If so, is that margin sustainable?

Performance of the Q-discount screen from Nov 08-

Source:Datastream

Rel to WIEROP$

Q discount screen worked well

In 2008.

Source: Quest Newsletter

Nov 2008

Page 19

Appendices

What is Quest™?

Decision support tool for equity investors

Impartial corporate financial analysis

Idea generation and idea validation

Combines conventional and proprietary metrics

‘Glass box’, not a black box

Web-based products – www.canaccordquest.com

Helping investors make money since 1996

Page 21

What is Cash Flow Return On Capital?

Cash Flow Return On Capital (CFROC)

– Real (replacement cost)

– Post-tax

– Return On Gross Invested Capital

Better insight into corporate performance and valuation (takes into account all the capital used, asset life, asset mix, return of capital)

IRR calculation not A/B

(A) Gross cash flow = €10

(D) Asset life = 14 years

(B) Gross invested capital = €100

(C) Non-depreciationasset release = €15

Cash Flow Return On Capital (IRR) = 6.0%

Wealth creation Screening

Risk managemen

t tools

Value tools Performance M&A

Stocks & Products

Page 22

Quest™ valuation overview

Cash Flow Returns in a DCF model

Use consensus forecasts – 2-years forward

Forecast gross cash flows – existing assets wind-down

Forecast growth rate – reversion to mean

Forecast Cash Flow Return On Assets – future investment returns (reversion to

mean)

Forecast net cash flows – implicit

Discount back using WACC for Enterprise Value

Reversion to the mean

High CFROA Low CFROA High growth

Page 23

A broad-based view

Five Value factors:

Quest™ valuation

Quest™ market-to-book

EV/sales rel LRA

Dividend yield rel LRA

P/E rel LRA

Mix of absolute and relative measures

Value

Tesco: Quest™ valuation

Centrica: Dividend yield relative to market and history

Page 24

Aim to emulate the Quest™ Strategy page

Is it a good or a bad company?

High return/ growth stocks

Five Quality factors:

CFROC spread (5-year average)

Real capital growth (3-year average)

Equilibrium growth (3-year average)

Fixed charge cover (solvency FY1)

CFROC change (FY1)

Measures ability to generate shareholder value

: Quality

Tesco PLC: Cash flow returns

Tesco PLC: Invested capital and equilibrium growth

Page 25

Combination of price and earnings

Five Momentum factors:

Nine-month relative trend

100/200 day switch

12-month relative range

30/90 day switch

Earnings momentum (consensus)

Mixture of long, medium and short-term measures

: Momentum

Page 26

Each stock is compared to its universe

All 15 factors ranked in deciles

– 10 = ‘good’, 1 = ‘bad’

Add the five measures in each category and divide by

1.5

– Gives scores for Value, Quality and Momentum (/33)

Add together category score to get overall triAngle

score

Rank all the stocks in the universe, then re-decile

How the triAngle score is calculated

Page 27

triAngle history: Value, Quality and Momentum

12 years of live triAngle history

Value works in short sharp burst – normally when valuation dispersion is high.

During the credit crunch, and in H2 2011, Quality and Momentum were the main drivers

Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials.

Page 28

Pan-Euro market-to-book performance

Page 29

Quality filters don’t help when the market takes

off

To 23 May 2012

But, will there be a ‘dash for trash’ this time?

Q discount has lagged

behind

Or did we see it in January?

Performance: Global Style Matrix: Risk off gainWealth creation Screening

Risk managemen

t tools

Value tools Performance M&A

Stocks & Products

Data to 18th May 2012Source: Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials.

Page 30