A year after Lehman Brothers' demise, it's easy to come up with a laundry list of factors that led to a near collapse of the financial system. One item that's been ignored is the mindset of the financier, particularly the budding one.
I had the opportunity to get to know dozens of such would-be financiers when I spent a year as a visiting fellow at Columbia University. The fellowship involved being part of an MBA class. The key course is an introduction to corporate finance. It's where you learn how to do a discounted cash flow analysis of a business.
In the deal-making sphere, people kneel down before the DCF. It's a means of valuing a company, by placing a present value on future cash flows. You learn how to project those flows, based on assumptions about a business, an industry and economic conditions. Those cash flow projections then become essential to the final valuation - the price. Of course, the price is what seals deals, and doing deals seals fees. You get the drift.
To do a DCF, you learn how to build a complex model in Excel. When you examine a case, you plop your calculations and assumptions into the model and it will spit out a value.
There are other ways to value a business. Does a company have a competitive advantage? How is it valued versus its peers? What is the sum of its parts? But the DCF is part of the basic financier's kit, allowing him to fall back on something vaguely scientific.
Doing a DCF analysis is not easy. At least it wasn't for me. Because the work is tough, you tackle the assignments in groups of six. The idea is to foster teamwork. I was the oldest in the room, and the rest were whip-smart. So I was way behind from the start. I didn't even have a working knowledge of Excel. I also had a Mac laptop, rather than a PC, which added to my profile as a loser.
As you work through the assignments, you get to a point where you have to make assumptions about worst-case profit margins. You come to this by assessing the risks, getting clues from data embedded in financial statements and documents provided. But as we know with accounting, there is discretion and creativity involved.
This is where you begin to understand the brain of the budding financier. He wants to show he's aggressive. But you quickly discover he knows squat about risk management.
As we debated what a reasonable number would be for a profit margin for the case, I singled myself out as the party pooper. I came in with a depressingly low number. Who invited this old coot, anyway?
My argument was that companies frequently don't do as well as you hope, and you realize things aren't always hunky-dory. As it turned out, my simpleton case wasn't good enough for the group. Overruled!
Meantime, as everyone was toiling to master the DCF, recruiters - from sturdy firms such as Lehman Brothers, Bear Stearns and Merrill Lynch - roamed the school's halls. To be taken seriously, you had to be able to knock out a DCF in your sleep.
When it came time for the exam, I had learned to use Excel and I had built my own model. I knew I could do a DCF. I could value a company the same way those cigar chompers on the street could.
We were presented with a case involving a takeover of a tech company. We had to value it. The exam would take five hours, from 9 a.m. until 2 p.m. I was well stocked with granola bars, bananas and other munchies. I worked away, making my cautious assumptions, plugging numbers into my model step by step. The time evaporated, but I got a value for the company. That was the requirement to pass.
I won't tell you my grade, but I squeaked through. Rest assured, I was near the bottom of this group of larval-stage financiers. But I must say, I'm proud of my low standing. Lehman Brothers wouldn't even have given me a passing glance.
Howard Green is anchor of Headline and Market Call with the Business News Network.