The role of an investment analyst
An investment analyst is a financial expert who, as its name implies, evaluates investment projects through complex marketing researches and financial analysis. The role of an investment analyst is to assist management in determining the profitability of an investment. On a daily basis, the investment analyst will work hand-in-hand with other departments such as Development, Legal or Operations in order to have a full understanding of each deal’s background and specificities. The hospitality sector being very diverse, there is a multitude of investment types whose complexity varies according to the contract (franchise versus management contract), funding options, location, brand or contract terms. That is why more complex is the deal, a more experienced analyst will be preferred and advantageous. It is common for an analyst to focus on specific niches to become with time expert in their chosen area. Most of the time an investment analyst will be allocated a specific region to look after, but he can also focus on specific contract types such as franchise agreement only, or for a specific asset class.
When a hotel group is looking to sign a contract with a franchisee or with a hotel operator, the expertise of the investment analyst is most of the time required before signing the contract, when the developers are negotiating the terms of the contract. While the developers are looking for maintaining good relationships with their owners/operators and to sign a maximum of deals, the financial analyst is advising the developers as to which contract terms will guarantee a maximum of profitability.
The process of an investment analysis
Hotel investment became a very complex business field as the parties’ profile getting involved diversified as well as the different operating models. The emergence of different agreement types between operators/owners/brands and the increase of the competition stresses, even more, the importance for investors to master the art of forecasting. The study of a proposed property is commonly referred to as an ‘economic feasibility study’ or simply ‘feasibility study and includes, first, a market study with operating projections, and then, a financial study of the return on investment for the subject property.
The financial analyst will consider the following elements:
- Market Area Characteristics: the location of the property within a primary or secondary city will directly influence the hotel demand generators such as means of transportation, tourism attractions and commercial & industrial activity.
- Property Analysis: few elements are important to consider before positioning the subject property within the competition such as its market class, its room inventory and size, and its type of facilities and architecture. Identifying those elements can help to determine any costs of refurbishments that need to be considered when calculating the return on investment.
- Competition: STR reports can provide relevant information regarding both branded and independent operating hotels in the surrounding’s area of the property. Selecting the hotel’s direct and indirect competitors is key to successfully position the subject property within its market. Similarly, identifying the hotel pipeline gives an idea of the potential market growth in the upcoming years and, thus, of the property’s ease to uplift its RevPAR.
- Estimates of operating results: According to the above elements the analyst can forecast annual revenues and expenses at stabilized occupancy and average daily rate (ADR). Note that the sensitivity of those projections depends on the currency and inflation rate used.
- Profitability of the investment: calculation of the economic impact on the value of the investment through discounted cash flow or direct capitalization analysis. An investment is considered feasible when its future economic value is greater than its cost and will provide return on investment (ROI).
Key Financial terms
One of the most important financial principles for an investment analyst is the ‘time value of money’. This concept holds that the money in the present is worth more than the same sum of money received in the future. This takes his sense when you know that the money you hold now can be invested and therefore earn a return, or also, that factors such as inflation can decrease the value of your money. The time value of money is therefore referred to as the net present value (NPV). Thus, an investment analyst needs to adopt this approach when determining the future value of an investment made today.
A special formula can be used to calculate the future value of money:
Future Value = Present Value * (1+(i/n) ^ (n*t)
FV = the future value of money
PV = the present value
i = the interest rate or other return that can be earned on the money
t = the number of years to take into consideration
n = the number of compounding periods of interest per year
The total revenue generated by investment will first depend on the contract terms biding the parties such as the fee structure. In the case of a franchise agreement, the analyst will determine the royalty fees earned by the investor (hotel group) over the contract period. On the other hand, in the case of a management contract, the analyst will determine two sources of revenue: the base management fee and the Incentive Management fee.
*Incentive Management fees can be calculated based on:
GOP (Gross Operating Profit): Profit left after deducting all department expenses from the revenue.
AGOP (Adjusted Gross Operating Profit): GOP less Base Management Fee
NCA (Net Cash): Amount of cash remaining after deduction of the total liabilities.
Once the sources of revenue of the investor are identified, comes the time to calculate the net present value of the investment. On the other hand, how much money would my investment of X have generated after X years? To do so, the analyst will proceed to what we call the Discounted Cash Flow Analysis.
The discounted cash flow (DCF) formula is based on the future value of money calculation as mentioned above.
DCF = (CF / (1+R) ^ 1) + (CF/(1+R) ^ 2) + … + (CF/(1/R) ^ n)
- (CF): The cash flow represents the net cash that the investor will receive in a specific period (royalty fees for instance).
- (R): The WACC (weighted average Cost of Capital) refers to the required rate of return for the investor.
- (n): Period number can refer to number of years but also quarters or months.
The DCF is an important tool used by analysts as it tells you how much you will be willing to pay for something based on how much you expect to earn from it. The total discounted cash flow of investment is also referred to as the Net Present Value (NPV) and is one financial parameter used when evaluating any investment. Today investment analysts use complex excel models that allow them to proceed to those calculations quicker and to consider other commercial terms such as Key Money or Owner Priority Return.
Skills of an Investment Analyst
Many investment analysts are ambitious and driven. To make sure you are a good fit for an investment analyst career here are the main skills that are considered important:
- Curious: an analyst needs and must be curious, as its role implies lots of researches and investigation. Most of the information not being given, the investment analyst needs to constantly challenge himself to have a full understanding of his environment.
- Confident: Being confident or at less pretending to be confident is key when comes negotiations and time to justify financial projections. An investment analyst needs to be able to defend his ideas against high levels of questions.
- Technology ally: being technology friendly is a must as the analyst is required to quickly perform calculations of high-level complexity and to provide reports accordingly.
- Analytical: Building financial models is a very complex task, and any small mistake can easily lead to completely different conclusions. Attention to detail is very important and is usually strengthened along with experience.
- Resilient: Ability to withstand adversity or failures and bounce back from a difficult time. The investment analyst will have to cope with stressful situations and not always victorious outcomes.
- Communicator: Having good written and verbal communication skills is critical to be able to share your value with your team or associates and clients. An investment analyst is asked to communicate complex financial analysis in simple and direct words.
If you are looking for help to analyse your hotel investment or if you would like help with any aspects of your hotel revenue management and hotel technology, please don’t hesitate to contact us. Visit the Contact page to get in touch now