Ten buy-side interview questions you need to know, with answers

Jumping to the buy-side is no easy task. Most hedge funds, private equity firms and alternative asset managers interview a tiny percentage of candidates who apply and only hire a select few who actually make it through the door. While the interview process is different at every company, buy-side firms are known to ask some off-the-wall brainteasers to go along with more traditional interview questions.

We’ve compiled a selection of each style below. They are actual questions that were asked by buy-side firms of junior and mid-level candidates who then shared them with us. We also updated the piece to include responses from a reader who works in the industry. How'd they do? 

1. If you are McDonalds, which is better: A 5% increase in the price of all existing products (assuming price inelasticity) or a 5% increase in total volume as a result of a new product?

(A 5% increase in prices, because it has a greater impact on earnings. A 5% increase in volumes as a result of a new product launch comes with fixed costs associated with the research necessary to design the new product as well as variable costs, which mainly consist in raw materials purchases.)

2. If I ask you to research a company, what is the first thing you’ll look at: cash flow, income statement or a balance sheet? Why?

(Cash flow. As long as you can sustainably generate sufficient amounts of cash, not much else really matters. That is especially true if you interview with an LBO fund that would be very focused on debt repayment capacity.)

3. What will you do if the stock falls 20% after one month of your buy recommendation?

(Depends on the reasons of the dip. If you have good reasons to believe there is a catalyst for a price recovery that will make the stock price go higher than the price before the dip, just hold on to the stock. If the dip is due to new information that strongly affects your initial investment thesis, you should just cut your losses.)

4. What ratios would you analyze to understand the liquidity, the efficiency and the profitability of a company?

(A couple examples for each, feel free to add :
Liquidity : working capital ratio, interest coverage ratio
Efficiency : capital expenditure as % of sales, any cost item as a % of sales
Profitability : gross margin, ebitda margin)

5. What kind of financial modeling have you done in the past?

(For LBO, should demonstrate experience with advanced debt modelling with different tranches of various characteristics as well as experience with detailed operational modelling – detailed revenue build-up, detailed modelling for every cost item.)

6. Let’s say I have two envelopes. And I tell you that one has twice as much as the other one. You open the first one and it has $100. You may open the second one but you forfeit the $100. What do you do?

(Take the second envelope and forfeit the first one. The second envelope has either $50 or $200 in it, which means the average gain realized by forfeiting the first envelope is 250 / 2 = 125, which is greater than 100.)

7. You work on the sell-side. Why do you want to join the buy-side?

(Typical responses include working more in-depth on projects, more exposure to senior people and management of portfolio companies at a junior level, use of judgement rather than commercial skills due to being a decisionary part rather than an advisor, PE being more "complete" than most sell-side jobs due to exposure to operational, financial, legal, and tax aspects.)

8. There are two companies in the same industry. One increases price and the other invests to increase production capacity. Which one would you rather invest in?

(Need to assess price elasticity and current state of supply vs. demand to provide a good answer.)

9. What are some of the weaknesses of a PE (price-to-earnings) valuation?

(P/E being a ratio, it has all the typical flaws of a ratio : the perfect comparable does not exist, it is market-based and markets may not be a reflection of true intrinsic value, etc. More specifically, P/E is highly dependant on financial structure, which may "distort" valuations when comparing companies that have different levels of leverage.)

10. So you play poker. What are the odds of flopping a flush if you have two cards of the same suit? What if there is $200 in the pot and the guy ahead of you bets 40. Do you call? How many people must call before you to have good, "pot odds"?

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