Applied Investments Program 1

Costco Wholesale Corp.

Ticker: COF Change Insider Positions: +3.09%

Current Price: $78.32 EV/EBITDA: 8.96

52 wk. high July 2014: $85.39 Market Cap (mil): $43,151

Bberg Fair Value: $91.71 Shares (mil): 551.6

MStar Fair Value: $93.00 Sector: Financials

Beta: 1.05 Net Inc. Margin: 18.55%

EPS T12 $7.66 P/E T12: 10.2

P/E: 10.21 ROA: 1.5%

5 Yr DuPont ROE 10.78% Consensus Rating: 4.27

Stewardship rating: Standard

Morningstar credit rating: A-

Economic Moat: Narrow

ROE 2014: 10.02%

Dividend Schedule: 02/20/2015 Cash Div. $0.30

11/20/2014 Cash Div. $0.30

08/21/2014 Cash Div. $0.30

05/22/2014 Cash Div. $0.30

Stock Type: Cyclical

Stock Style: Large value

Wall St. Recommendations

Buys 21

Holds 12

Sell 0

Liquidity/Financial Health

(Latest Quarter)

Debt/EBIT 7.38

Revenue Growth 4.06

Operating Margin 24.43

Debt/Equity 1.1

Company peers

Visa Inc.

MasterCard Inc.

American Express Co.

Discover Financial

Profitability C

Price/Book 1.0

Price/Sales 2.0

Price/Cash Flow 4.7

Price/Earnings 10.3 DCF Model Results

AIP FCF Capital

One.xlsx

Research Highlights and Investment Thesis Research Highlights

Capital One has been able to stay well below average provisions for credit losses when looking

at peers; Discover, American Express, and Synchrony Financial.

Improvements in operational efficiency coupled with investments in technology have

contributed to the company’s ability to grow net income at an average rate of 12.22% over the

past four years, while revenue has grown at a rate of 6.32%. Further, strategic acquisitions have

also aided in the growth of Capital One’s revenue and net income, while adding diversification

to Capital One’s portfolio of business segments. Based on recent decreases in unemployment

and better than expected improvements in the economy coupled with a strong dollar we expect

consumer spending to increase over the next few years.

Capital One’s Net Charge-off rate decreased by 32 basis points in 2014 down to 1.72% from

2.04% in 2013. The company expects that this will continue to decline with continued

improvements in economic conditions. Additionally, the company’s loans held for investment

increased by $11.1 billion to $20.8 billion.

Capital One has earned a narrow economic moat due to their position as the leading credit card

issuer in the U.S. credit card market. Richard Fairbank has been chief executive officer since

1994 and has improved the company’s diversification through successful acquisitions of

multiple companies. Since 2005 Capital One has expanded its retail banking arm by acquiring

Hibernia National Bank in 2005, New York Based North Fork Bancorporation, and Chevy

Chase Bank in 2008. Capital One also purchased ING’s American ING Direct division, HSBC’s

credit card operations, and lastly in January 2015 Capital One acquired level money, a mobile

budgeting app. Finally, Capital One also purchased Best Buy’s credit card portfolio for $7

billion which was sold less than one year later.

Investment Thesis I recommend a buy on Capital One, when taking into account my DCF analysis, and my research of the

company. I believe Capital One can make for a beneficial holding to our portfolio by further equalizing

our weight in financials as well as adding diversification to our holdings within that sector. I would like

to invest 2.5% of the fund in Capital One and derive funds for investment from multiple sources;

Financial Select Sector SPDR (1.5%), CVS Health (0.5%), and Wells Fargo (0.5%). Alternatively, in

spite of transaction costs the fund may prefer to pursue investment in Capital One with a sources of

funds derived from the Financial Select Sector SPDR, but I believe we should consider the earlier

option. The main reasons I would like to draw from Wells Fargo (0.5%) and CVS Health (0.5%) is that

both have exceeded their adjusted sell targets. CVS Health has exceeded its adjusted sell target by

about 16% and has been flat to slightly down since mid-February. Additionally, I would like to draw

0.5% from Wells Fargo as part of a financial sector rebalance. We have owned Wells Fargo since

December of 2012 and the stock has grown from $35.06/share to their current price of $55.59/share.

This strong growth in share price has caused WFC to account for the largest holding within the

portfolio at 4.21% followed by CVS at 4.07%. Given the fact that both holdings have exceeded their

adjust sell target and have become very large positions within the portfolio I see some significant risk

associated with holding over 8% of our fund in positions above their adjusted sell targets and

recommend a slight trim of each in an effort to reduce that risk and rebalance those holdings.

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Applied Investments Program 2

Business Description Notes Capital One has significantly improved

is position and diversification since 2005 and has had a strong leader through many acquisition that we expect to continue to offer insight for the company going forward.

The company’s Net charge-off rate is a percentage representing the amount of debt a company believes it will never collect compared to average receivables.

Balance sheet total loans outstanding (USD millions)

Provision for loan losses as a % of

total loans

Net Charge-Off Rate %

Business Description Capital One Financial Corporation is a diversified bank, which through its

subsidiaries, offers a broad spectrum of financial products and services to consumers,

small businesses and commercial clients both domestically and internationally.

Capital one was established in 1994 and was headquartered in McLean, Virginia.

In November of 2013 Capital One acquired Beech Street Capital, a privately-held,

national originator and servicer of Federal National Mortgage Association (Fannie

Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal

Housing Authority (FHA) multifamily commercial real estate loans. This acquisition

was used to expand and enhance the company’s existing multifamily capabilities.

Capital One (COF) is traded on the New York Stock Exchange and is included in the

S&P 100 Index.

Capital One’s expenses are generally derived from provisions for credit losses,

operating expenses (including salaries and associate benefits, occupancy and

equipment costs, professional services, communication and data processing expenses

and other miscellaneous expenses), marketing expenses and income taxes.

Capital One is broken up into three main segments being:

Credit Cards: Consists of domestic consumer and small business card lending.

Consumer Banking: Consists of branch based lending and deposit gathering

activities for consumers and small businesses, national deposit gathering, national

auto lending and consumer home loan lending and servicing activities.

Commercial Banking: Consists of lending to companies with annual revenues

between $10 million and $1 billion.

Capital One must abide by limitations set by the Truth in Lending Act, the Equal

Credit Opportunity Act, the Fair Credit Reporting Act and the Service members Civil

Relief Act.

Capital One has approximately 46,000 employees and invests heavily in information

technology to achieve the company’s business objectives. Investments in efficient,

flexible computer and operational systems such as cloud technology aid to support

complex marketing and account management strategies.

Capital One reported net income of $4.4 billion on total net revenue of $22.3

billion for the year ending 2014, which was derived from all three business

segments.

In 2014 the three business segments accounted for the following portions of

operating income (millions):

Credit Card $3,808

Consumer Banking $1,860

Commercial Banking $1,025

On March 26, 2014 Capital

One’s board of directors

announced a $2.5 billion stock

repurchase program. Through

Capital one was able to repurchase

approximately $2.0 billion worth of their $2.5 billion repurchase program. The

company expects to complete the stock repurchase program within the first quarter

of 2015.

Capital One is one of 31 banks that must submit to the Comprehensive Capital

analysis and review, as well as the stress tests administered by the Federal Reserve,

which will be discussed later.

Capital One serves clients both domestically and internationally and has bank

locations in Connecticut, Louisiana, New Jersey, New York, Virginia, Maryland,

Texas, and the District of Columbia. Similarly, Capital One is one of ten of the

largest banks based on deposits as of December 31, 2014.

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Applied Investments Program 3

Percentage of portfolio financials sector holdings

Financial sector holdings

adjusted sell target upsides

Financial sector holdings adjusted sell target v current stock price

Capital One Morningstar fair value,

sell target & current price

Capital One Historical Chart (COF) Financial sector holdings performance since purchase

Portfolio Positioning Currently, when adjusting for our holdings within the “funds” sector we are underweight the

financial sector by 3.87% which is our second largest underweighting falling just below our

significant underweight in the Healthcare sector. Financials account for 12.95% of our portfolio

and our holdings are American Tower Corp (1.95%), Goldman Sachs Group (3.21%),

JPMorgan Chase & Co (3.07%), and Wells Fargo & Co (4.11%). We appear to be in a strong

position within this sector as nearly all holdings currently have some upside based on their

adjusted sell targets. The sector currently has a weighted average upside of 9.23%. The weakest

of all four holdings appears to be Wells Fargo, which accounts for our largest holding within the

financial sector, while also having an estimated negative one percent upside. Based on these

conditions it is my recommendation that we consider trimming some of our Well Fargo holding

as part of a rebalance within the sector while using a portion of that to fund investment in Capital

one. Our current holdings in the financial sector were acquired over a period of approximately

two years with our first position being Wells Fargo, purchased December 20, 2012 follow by

Goldman Sachs February 2, 2014, then JP Morgan March 26, 2014, and lastly American Tower

May 20, 2014.

The four holdings are highly correlated, excluding American Tower, mainly due to

operations within the financial sector and more specifically, the Investment Banking

and Corporate Banking subcategories. Overall, American Tower has the lowest

correlation relative to other holdings with an average correlation of about 0.79.

Additionally, we can see that our four holdings within the sector are highly correlated

with Vanguards Financials ETF (VFH)

All of our holdings within the financial sector of the portfolio have a narrow moat for

varying reasons:

Goldman Sachs: Morningstar provides a narrow moat on Goldman because of their

ability to recruit highly talented employees, maintain strong brand recognition and

the firm’s competitive advantage for garnering investment banking deals.

JP Morgan: Morningstar gives JPM a narrow moat due to their massive scale and

cost advantages. Morningstar also cites JPM’s intangible assets and switching costs

in their asset management and treasury services operations.

Wells Fargo: Earns a narrow moat because of their low-cost deposit base, and a

business model built on customer service and cross-selling.

American Tower: Earns a narrow moat because the firm has the best tower

portfolio quality and nearly all of their domestic towers were by tower firms or

legacy carriers such as AT&T and Verizon.

Lastly, Capital One earns a narrow moat due to their position as the leading credit

card issuer concentrated in the U.S. Credit Market and its low cost deposit base.

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WFC JPM GS AMT

Current Price

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Px Last

Fair Value

Sell Target

Buy More

Bberg Mstar

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Applied Investments Program 4

Capital One Feb 26 purchase stock vs sell put payoff

Capital One Bond Issue YTM v Bond price 3.2% 2025 Maturity

Capital One Bond Issue YTM v Bond price 1.65% 2018 Maturity

30/02/15 Treasury Yield Rates

Recent News March 11, 2015 Capital One announced that the Federal Reserve has completed is

2015 Comprehensive Capital Analysis and Review and did not object to Capital

One’s proposed capital plan that was submitted on January 5, 2015. Additionally,

Capital released news that it plans to increase the quarterly dividend on common

stock from $0.30/share to $0.40/share which is the first increase in the company’s

dividend since February 7, 2013 when the company raised the dividend from

$0.05/share to $0.30/share.

Also on March 11, 2015 Capital One indicated plans of a large stock repurchase

program to begin in the second quarter of 2015. The company plans to extend the

program into the second quarter of 2016 and estimates the repurchase of $3.125

billion worth of shares over the course of the program. The timing and exact amount

of the program at this time are unknown and will be adjusted based on market

conditions, opportunities for growth, the company’s capital position, and the amount

of retained earnings. Similarly, management has not released details on any specific

price targets or whether they plan to carry out the buyback program through open

market purchases or through privately negotiated transactions.

On March 5, 2011 Capital One announced that it will apply $150 million in

community grants and initiatives over the next 5 years to help empower more

Americans to succeed in an ever-changing digitally-driven economy. Capital One

will carry out this plan through the use and launch of their “Future Edge” program.

On February 26, 2015 Capital One appeared in the news on Forbes due to an

attractive setup in the options market. New options began trading for the April 10,

2015 expiration date allowing an investor to sell a put contract with a $72.00 strike

price while collecting a premium of $0.04 while the stock was trading at $79.34.

Because selling a put option is a bullish position that is very similar to owning the

stock an investor that wanted to buy Capital One could engage in this transaction and

could in essence purchase Capital One at a discount. This strategy would work for

someone who was interested in owning Capital One if the option expires in the

money and is exercised. The writer of the put option will be required to buy Capital

One from the individual who purchased the put option. This is beneficial because the

investor wanted to own Capital One anyway and can collect the premium essentially

improving their payoff on the stock by $0.04/share. http://www.forbes.com/sites/stockoptionschannel/2015/02/26/april-10th-options-now-available-for-

capital-one-financial/

http://finance.yahoo.com/q/op?s=COF&date=1428624000

Furthermore, on February 5, 2015 Capital One sold $1 billion in BBB rated bonds set

to mature February 5, 2025. The bonds were issued by Barclays Capital, Capital One,

Deutsche Bank, JP Morgan, and Morgan Stanley, and will pay 3.2% semiannual

coupons, which will likely be used to fund the company’s planned stock buyback

program. The firm also issued $1.6 billion in BBB+ rated shorter maturity bonds. The

shorter maturity bonds will pay semiannual coupon payments of 1.65% and the bonds

will mature February 5, 2018. Capital One and other corporations have been issuing

bonds at a breakneck pace likely due to the anticipation that interest rates will rise in

the somewhat near future. Issuing bonds at the current low rates allows a corporation

to lock in lower interest payments on a portion of their debt for years to come further

reducing their annual interest expense. http://www.treasury.gov/resource-center/data-chart-center/interest-

rates/Pages/TextView.aspx?data=yield

Many multinational company’s engaging in global operations cite the large tax that

the firms may face if they attempt to transfer profits earned outside of the U.S. back

into the U.S. Given this information many firms are turn towards issuing bonds to

maintain operations and avoid the tax as long possible.

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Applied Investments Program 5

Return on Common Equity 2014

Effective Tax Rate FY 2014

Operating Margin T12 Month

Net Charge off to Average Total

Loan (Avg CC 100 banks 3.3%)

Net Debt to Shareholder Equity

Financial Statements Analysis

Capital One appears to be in a strong financial position citing the recent increase in

the quarterly dividend from $0.30/share to $0.40/share coupled with the firms plans

to pursue a large stock buyback. Additionally, the firm has a long history of making

strategic acquisitions to grow the operations and add diversification. Similarly,

Capital One has one of the lowest EV/EBITDA ratios when comparing similar

companies; Capital One (8.96), Discover Financial (8.73), American Express (11.47),

Visa Inc. (23.57), MasterCard (15.45), Synchrony Financial (9.11).

We expect that Capital One should have no trouble paying short or long term debt

obligations. Even with the recent stock buyback, funded mainly by debt,

announcement the firm is not highly leveraged with a Low Leverage Ratio, of 6.99,

relative to other firms, and a debt to equity ratio of 1.06 in the latest quarter.

Likewise, Capital One may help to slightly reduce the overall risk within our

Financial sector holdings as Goldman has a financial leverage ratio of 12.2, followed

by JP Morgan at 12.1, then Wells Fargo at 10.1, and lastly, American tower at 5.56.

The company has been able to maintain an issuer credit rating of nearly all “BBB+”

rated bonds and I expect Capital One to continue to maintain low default risk on all

debt. Additionally, Capital One had slightly over $47 billion in long term debt on the

balance sheet at the end of 2014 with $62 billion in Total investment assets and $3.1

billion in cash and near cash items, thus suggesting Capital One will maintain short

term and long term interest payments. Furthermore, the firm’s long term assets have

grown from $169 billion in 2009 to $308 billion in 2014. On average Capital One is

able to payout slightly less than 15% of its earnings in dividends.

Capital One has been able to make continuous acquisitions while sustaining strong

returns on capital. Additionally, the company has had positive and negative free cash

flow over the past few years as the company makes significant investments in

infrastructure, mergers, and acquisitions.

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Applied Investments Program 6

Revenue Growth 2009-2015

Source: Bloomberg data analyst developed chart

Net Income Growth 2009-2015

Source: Bloomberg data analyst developed chart

Net Income Margin 2009-2014

Source: Bloomberg data analyst developed chart

Credit card loan growth 2009-2014

Cash Flow Breakdown

In 2014 Capital One’s cash flow from operations amounted to -$6.8 million with $3.8

billion generated in operating Income within the credit card segment. $2.4 billion in

net income was also generated within the net income segment.

Within the Consumer Banking segment Capital One was able to generate $5.7 billion

in net interest income while allowing for only $703 million in provision for loan

losses.

Lastly, from 2009 to 2014 credit card segment total deposits have grown from $74

billion to $168 billion along with commercial banking total deposits growing from

$20 billion to $31.9 billion

Capital One’s segment and product line diversification has added to their ability to

compete with other large credit card companies such as Visa, MasterCard, and

American Express. Likewise, through acquisitions Capital One has improved their

ability to compete with firms like Citigroup and Bank of America. Capital One is working on expanding their consumer banking operations across the US to further add to

segment growth.

Income statement analysis

Capital One’s revenue has grown significantly from 2010 to 2014 and has kept the strong

pace of 11.21% per year. In 2009 Capital One had $12.9 billion in revenue growing to

$22.3 billion in 2014.

Impressively, Capital One’s provision for loan losses has remained relatively steady and

has even decline in some years. This occurrence can be attributed to better collection

practices as well as better economic performance.

Lastly, given the fact that Capital One is in the financial sector and lacks a hard

asset/manufacturing-type of supply chain, they do not rely on a long list of suppliers, as

would a manufacturing company. Rather, the company is able to indirectly be affected by

approximately 14 suppliers including; Oracle Corp, IBM, Google, Bank rate, Experian,

Fiserv, salesforce.com, Open Text Corp, Twitter Inc, CoStar Group Inc, Verisk

Analytics, Zebra Technologies Corp, Compuware Corp, and lastly Verisign Inc.

Balance sheet analysis

Total Commercial Loans have grown from $29.6 billion to $50.9 billion in 2014

similarly, Capital One’s Total Consumer Loans have grown from $60.6 billion up to

$157 billion within the same time period.

Within Capital One’s consumer loans segment Credit Card Loans have grown at an

unwavering pace growing over 550% from 2009-2014 or from $15 billion to $85

billion in the short period.

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Applied Investments Program 7

Federal Reserve 2015 Results:

Federal Reserve Comprehensive

Capital Analysis

Adobe Acrobat

Document

Federal Reserve Required

Ratios (Severely Adverse

Conditions)

Federal Reserve Required

Ratios (Adverse Conditions)

Average unemployment rate by Yr.

Federal Reserve Comprehensive Capital Analysis and

Review 2015 Due to the financial crisis of 2008 large bank holding companies have built a

significant amount of capital on hand to protect the firm would a similar crisis take

place. Firms are evaluated on a series of stress tests administered by the Federal

Reserve and are required to make adjustments if they cannot comply to the fed’s

requirements.

During the 2015 analysis of Capital One, the Federal Reserve did not object to the

capital plan and planned capital distributors for 29 of the 31 bank holding companies.

Firms are analyzed on their ability to perform a certain way under seriously adverse

economic conditions. The fed uses a series of common capital ratios being;

Capital/Risk-adjusted assets = Capital Ratio, Total Capital (Tier 1 & Tier 2)/Risk-

adjusted assets = Total Capital, Capital/Average total consolidated assets, and

common stockholders’ equity/ Balance sheet assets = common stockholders’ equity

ratio.

Additionally, the Federal Reserve conducts reviews based on a qualitative assessment

and a quantitative assessment. The qualitative assessment focuses on the internal practices that a BHC uses to determine

the amount and composition of capital it needs to continue to function throughout a period

of severe stress.

The quantitative assessment focuses on the BHC’s ability to take capital actions described

in the bank holding company’s baseline scenario of its capital plan and maintain post-stress

capital ratios that are above a 5 percent tier 1 common capital ratio and above the applicable

minimum regulatory capital ratios in effect during each quarter of the planning horizon

Capital One was able to meet or exceed the Federal Reserve’s expectations when

placed in a scenario with adverse conditions and a scenario with severely adverse

conditions. Upon exceeding the Fed’s requirements Capital One announced their

$3.125 billion stock buyback program. Based on current economic conditions I

expect Capital One to meet the Fed’s requirements for the foreseeable future.

Economic Outlook Based on the International Monetary Fund’s economic projections for 2015 and 2016

we would expect continued improvement in world economic annual growth rates.

Looking back over the past few years advanced economies as a whole grew by 1.3%

in 2013 and 1.8% in 2014. Likewise, based on the economy’s historical performance

the International Monetary Fund (IMF) projects growth of 2.4% in 2015 and 2016.

Similarly, the IMF estimates that emerging markets & developing economies grew at

a rate of 4.7% in 2013 and 4.4% in 2014. The IMF places estimates that emerging

markets and developing economies will grow at a rate of 4.3% in 2015 and 4.7% in

2016.

The global economy as a whole has also offered strong performance over the past

two years growing at 3.3% in 2013 and 2014. Similarly, the IMF projects that the

global economy will grow at a rate of 3.5% in 2015 and 3.7% in 2016.

Some major developments in 2014 include the surplus in oil production resulting in a

massive decline in oil prices, a significant appreciation in the U.S. dollar and a

decline in the Euro. Furthermore, the U.S. economy grew at a faster rate than most

other economies. We expect this trend to continue for the foreseeable future as the

Federal Reserve begins to raise rates and the US sees increases in domestic

investment as foreign investors move funds into the US attempting to take advantage

of the carry trade. As foreign investors move funds into the US in pursuit of the carry

trade we expect an increased demand for the US dollar causing further appreciation

relative to other currencies. We expect that further appreciation of the US dollar

coupled with increases in domestic investment from foreign entities will add to this

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T1 CommonRatio

T1 CommonEquity

T1 CapitalRatio

TTL Risk-based Cap

T1 LeverageRatio

Minimum Stressed Actual 2014 Q3

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Applied Investments Program 8

10Yr Government bond yields

by country

American Consumer debt by

segment (billions)

American historical credit card

growth

U.S. Department of Commerce

Disposable personal income

Total Outstanding Revolving

Debt (millions)

historic bull market that we’ve seen since 2009. Moreover, recent positive economic

news such as improved employment is expected to further contribute to any

additional growth in the overall market.

Adding to the decline in the Euro was the European central bank’s intervention to

depreciate the Euro by purchasing over $1 trillion in assets including government and

private sector bonds by September of 2016 and will extend the program if needed.

With the U.S. projected to grow at a rate of 3.6% in 2015 and 3.3% in 2016 we

expect to see rises in U.S. Consumer Spending due to rises in incomes over the next

few years. We expect rising incomes and increases in consumer spending to push

growth in credit card debt.

U.S. Consumer Spending The U.S. household consumer debt profile is as follows: average credit card debt

$15,611, average mortgage debt $155,192, average student loan debt $32,264.

Americans have a total debt of $11.74 trillion which has increased by 3.3% since

2013. Additionally, Americans have total credit card debt of $882.6 billion, total

mortgages of $8.14 trillion, and total student loan debt of $1.13 trillion. Between

2006 and 2008 credit card debt rose steadily and reached its height in 2009, six

months into the financial crisis, as unemployment grew to 10 year highs credit card

debt began to decline. Similarly, following the financial crisis consumers became

more frugal and paid off credit cards until 2011 where average household credit card

debt plateaued. Since 2011 credit card debt has been on a slight incline

Based on the performance for the period from 2006-2009 credit card debt grew at a

very fast pace in stride with the economy along with the rise of the housing bubble

which contributed to higher incomes. With those higher income levels came higher

borrowing until the crash in 2009 when household credit card debt peaked at

$19,900/household. As household income and credit card debt grew on the way up it

was further exaggerated as the economy began to collapse and individuals who

became accustomed to higher income began borrowing in an attempt to maintain

their new income further exacerbating the decline of the economy. http://www.bloomberg.com/news/articles/2014-12-23/consumer-spending-beats-forecast-as-u-s-

gasoline-prices-drop

http://www.bloomberg.com/news/articles/2014-02-07/consumer-credit-in-u-s-increased-more-than-

forecast-in-december

Because Capital One relies heavily on the issuance of credit cards to customers we

project that increases in consumer spending will lead to higher borrowing and

therefore will add to Capital One’s growth rate in the DCF model further improving

the company’s upside per share.

Total outstanding U.S. revolving debt in 2013 was equal to $847 billion. Americans

have created billions of dollars’ worth of debt over the past 45 years and credit card

debt has been a significant piece of the whole. Total Revolving debt increased

heavily in the 2008 financial crisis, while consumer spending declined. According to

figures from the Federal Reserve, total U.S. outstanding consumer debt was $3.33

trillion as of January 2015. This figure includes car loans, student loans, and

revolving debt, but excludes mortgages. Total U.S. outstanding revolving debt

mainly derived from credit card balances was $887.9 billion also in January of 2015.

Based on historical data, the United States current economic condition, and the

current economic outlook I expect to see continued growth in total revolving

consumer outstanding debt, which will lend to increases in total credit card debt.

**Revolving debt is debt that typically has a variable interest rate, an open-ended term

and payments that are based on a percentage of the balance. Revolving debt has a pre-

determined limit, agreed upon by the lender and borrower.

-0.50%0.00%0.50%1.00%1.50%2.00%2.50%3.00%3.50%

Un

ited

Sta

tes

Can

ada

Jap

an

EUR

(ge

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$- $2,000 $4,000 $6,000 $8,000

$10,000

$14,600 $14,800 $15,000 $15,200 $15,400 $15,600 $15,800 $16,000

$11,500

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2012 2013 2014

$700,000

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$850,000

$900,000

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Applied Investments Program 9

Comparables price/share

Comparables earnings/share

DCF Analysis

Discount Rate 8.0%

Discount Rate 9.0%

Discount Rate 10.0%

Sales Projections 2014-2018

Valuation Peer relative

Based on a peer relative valuation comparing Capital One to Discover Financial,

American Express, Visa Inc., and MasterCard Inc., the comparable companies’

analysis computed an implied fair value of $187.96. I found this value to be a little

high based on my own estimations, company market caps, and Capital One’s current

stock price. After analyzing the initial comparable companies’ results I further

limited the valuation model using an EQS. The EQS was limited to financial

companies within the sub sectors banks and diversified financials, companies with

similar market caps to Capital One at $44,780M, and lastly companies within the

United States. This EQS yielded seven results; PNC Financial(PNC), Bank of

Montreal(BMO), Bank of NY Mellon(BK), Capital One Financial(COF), Blackstone

Group(BX), Charles Schwab(SCHW), and lastly Canadian Imperial Bank of

Commerce(CM). These six additional companies were then analyzed against Capital

One and yielded more accurate results. The analysis also showed a more comparable

scenario in terms of EV/EBITDA, but I was unable to access all data from

Bloomberg to perform and impeccable EV/EBITDA comparison. The new

comparable companies’ analysis offered a lower implied fair value of $98.26 which

appears to be more accurate.

DCF Analysis

Inputs Sales growth: -1.0%, 5.5%, 8.7%, 3.6%

My estimates of company sales growth are slightly higher than consensus in the short

term but at or below consensus in the long term. I believe the company will continue to

maintain strong growth rates in the short term as they continue to make strategic

acquisition, but may face hardship over the long haul when acquiring other firms

becomes difficult due to market saturation. My 2015-2017 estimates are slightly over

or at consensus, but trail off to match the International Monetary Fund’s long term

global growth projections.

SG&A: 51.0%

Cogs of good sold will likely remain relatively stable, but may uptick slightly as

Capital One begins opening more banks, acquiring other firms, and pursuing new

markets.

Taxes: 32.0%

Taxes may increase slightly as the Obama administration has recently proposed a large

tax increase on American companies, specifically relating to overseas profits. Capital

One does not have significant exposure to international markets or exchange rates and

would likely not be adversely affected if there is increased incentive to hold money

outside of the U.S. Alternatively, there is some risk as the company expands operations

and considers acquiring firms or pursuing greenfield investments in a different country.

Debt 35.0%

Capital One is one of the lower leveraged financial companies within the sector having

a debt to equity ratio near 1. Recently, Capital One announced a $3 billion stock

buyback program which is expected to be funded primarily but debt. In order to

maintain a conservative DCF I understated my expectations of debt, but believe there

will be no material changes in Capital One’s capital structure into the future.

After performing the DCF analysis it appears that there is still be some upside left in

Capital One, the team should consider the health of our current financial holdings and

recognize that there is little to no upside left in Wells Fargo. Moving forward, the

team should consider companies within the consumer staples sector when searching

for a company to research, although I had a difficult time determining a consumer

staples company with remaining upside that would be a strong candidate to replace

our current holdings which let me to pursue research in the financial sector based on

Morningstar, Bloomberg’s fair value, and our significant underweight.

$25 $58 $91

$0.00 $4.00 $8.00

$21,000

$22,000

$23,000

$24,000

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$26,000

$27,000

$28,000

$29,000

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Applied Investments Program 10

% Upside to Sell Financial current holdings

Source: AIP price watch list

Applied Portfolio Sector holdings by weight

Capital One is one of the 10

largest banks in the US

based on deposits. Ranked

#145 on the Fortune 500 and

serving approximately 45

million customer accounts,

Capital One trades on the

New York Stock Exchange

under the symbol "COF" and

is included in the S&P 100

index.

Investment Risks Portfolio Positioning

Our current portfolio positioning poses some slight risk based on our current holdings

within the Financial sector. We currently have four holdings, one of which that has

exceeded its adjusted sell target being Wells Fargo. Wells Fargo has exceeded its sell

target of $55.35 while at the same time growing in to our largest holding within the

fund. Currently, 4.22% of our fund is invested into Well Fargo, given this

information I recommend we trim 0.5% to effectively help to rebalance our financial

sector holdings and to reduce the risk of having a large position in a company that

has exceeded its adjusted estimated fair value.

Recently issued debt

The recently issued debt of $3 billion could pose some risk if Capital One were

unable to maintain current levels of annual revenue to support debt payments. If the

company were to see a significant decrease in sales due to macroeconomic conditions

or serious systematic risks, the firm may be unable to make timely debt payments. I

perceive this risk to be quite small considering that Capital One has a low amount of

leverage, recent economic data suggests an improving economy, and Capital One’s

ability to effectively manage the firm’s assets.

Changes in accounting standards

Within the company’s 10k management offers some comment on risks associated

with changes in accounting standards. The company relies heavily on current

accounting standards and would face some significant risk if assumptions that

management currently has and operates on were to change.

Changes in legal standards

Changes in current legal interpretations and judgments could pose some additional

risks. If Capital One continues to operate based on assumptions of current laws and

regulations and those laws and regulations change the company could face some

legal risk, especially if laws relative to purchasing items through the gray market to

distribute through warehouses would become illegal in all cases.

Strategic Acquisitions

Components relevant to strategic acquisitions could pose some risk as Capital One

attempts to grow while purchasing company’s over time. There may be some

implementation risk in merging the new company with the existing company.

Technological Mishaps

Capital One relies heavily on technology and could face some serious risk. If the

company were to have a mishap it could result in significant losses passed onto the

company.

Conclusion and Recommendation In conclusion, I recommend a Buy on Capital One based on many factors. First, I

find the company below fairly valued when taking into account my DCF analysis,

Bloomberg estimated fair value, the comparable company analysis, and my research

of the company. Capital One appears to have some upside coupled with the strong

potential for growth. Similarly, our current portfolio positioning would be positively

influenced based on added diversification and further reducing the sector

underweight. Likewise, I will be recommending we trim 0.5% from Wells Fargo as

part of a rebalance, 0.5% from CVS based on my research and their exceeded sell

target offering a negative 16% upside, and lastly 1.5% from the financial select sector

SPDR. Overall, management has performed well and the company is expanding into

new markets which will continue to support their strong growth rate. After a

thorough analysis, I offer an intrinsic value on Capital One of $105/share taking into

account my DCF and comparable companies’ analysis.

-5%0%5%

10%15%20%25%30%35%

$2%

CD12%

CS10%

Ene.12%

Fin.13%Funds

6%

HC10%

Ind.11%

IT16%

Mat.Tele.1%

Util.3%

Applied Investments Program 11

Tables and Exhibits

Capital One vs Financial Select Sector SPDR ETF

Capital One Historical Price Chart (Feb 2013 - Mar 2015)

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Capital One v Financial ETF

Capital One Financial Select Sector SPDR