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QuickBooks 2004 Pro Business Financial Software + Books

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FINANCIAL PLANNER -Street Sign- investment book gift

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5 DAVE RAMSEY Childrens FINANCIAL Books LIFE LESSONS

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Financial Planning Answer Book (2008)

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Stech-Vaughn Financial Math Book One

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10 Books Investing Stocks Markets Financial

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QuickBooks Pro 2006 Quick Books Financial Software New

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Financial Valuation James Hitchner BOOK + WORKBOOK

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Becker CPA Review Financial FAR 2009 Book

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RARE 1880 NY HUNT MERCHANTS FINANCIAL CHRONICLE BOOK

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Learn how to interpret financial statement…

Analysis of Financial Statements by John J. Wild, Le...

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The Analysis and Use of Financial Statements by White

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Understanding and Analyzing Financial Statements Schoen

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FINANCIAL ACCOUNTING AN INTEGRATED STATEMENTS APPROACH

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Understanding Financial Statements by Ormiston & Fraser

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The Analysis and Use of Financial Statements by White

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Understanding Financial Statements by Aileen Ormisto...

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Understanding and Analyzing Financial Statements Schoen

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The Analysis and Use of Financial Statements by White

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The Analysis and Use of Financial Statements by White

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Sharpe Ratio: was invented by professor William Sharpe of the USA to find the true risk-adjusted return on investment.

It is calculated subtracting the risk-free rate of return from the annual total return on an investment. The result is then divided by the volatility of the investment (beta) to arrive at the Sharpe ratio.

Sharpe Ratio = (annualized return on the investment – Risk-free rate of return)/Volatility

Volatility = (Period high – Period low)/2 X 100/Current share price

Volatility is a statistical measure of past fluctuations in the price of shares on the stock market. It is often seen as being related to the risk of the stock (many argue against this), where the more volatile the stock price–the higher your risk of losing money when trading it.

The Sharpe ratio is a elegant concept that can be applied to almost any investment that produces a return and where volatility can be calculated. Another ratio, called the Sortino ratio, is derived from the Sharpe ratio. The Sortino ratio assumes investors are not worried about total volatility, but only volatility below the mean price (where they can lose money). It is thus calculated similar to the Sharpe ratio with the same numerator, but the denominator is adjusted for only below mean deviations.

Reinvested Return on Equity: is a way to project the future value of a company based on ROE, dividend cover, the risk-free rate of return, and the internal rate of return.

To simplify this rather complex mathematical formula, we have provided below the Prof Sage Short Version of what we call Intrinsic Value. Intrinsic Value is not the same as Reinvested Return on Equity, but the concept is very similar. The best way to learn the Intrinsic Value calculation is by real examples with listed companies, and we provide an example using People’s Food below. It is important to remember that Intrinsic Value is an approximation and cannot be expected to predict the exact value of a business in future years.

Discounted Cash Flow (DCF): is a way of valuing companies by forecasting flow for a period of years into the future and applying a discount factor to each year’s figure to reflect the expected time until it accrues. The further in the future, the greater the discount applied to that year’s cash flow. (Think about it, if I owe you $100 and promise to pay you next week–you are OK with it, nut if I promise to pay in 9 years, you have some concerns, right? This discounting idea shows the decay in value of a dollar for every additional year it takes you to actually see it arrive in you pocket.)

The discounted cash flows for each of the years are added together, and additional value is placed on the total cash expected to accrue beyond that point, and the total is then compared with the market value of the company.

DCF = Free cash flow year 1 X (discount factor for year 1)…etc… +Free cash flow year 10 X (discount factor for year 10) + PV (value to perpetuity)

Using DCF is a good way of getting a handle on whether a particular share represents good value or not–and it’s solid based in earnings. The challenge is to accurately project an accurate discount factor and the company’s earnings growth rate into the future. Warren Buffet uses DCF to value companies he invests in, and since he’s the greatest mind in equity investing today (or any day), we should strive to learn this method. Buffet advises we focus on being approximately right, and not precisely wrong-otherwise, don’t get bogged down in the details but see the bigger picture. Prof Sage will present a short-version of Intrinsic Value below.

Weighted Average Cost of Capital: (WACC), is usually compared with the actual return on capital earned by a company to determine how much value (if any) management is adding for shareholders (Economic Value Added-EVA). The calculation “weights” the cost of equity with the percentage of share that equity represents in the capital structure, and the cost of debt with the percentage share it represents, to produce a composite figure.

WACC = Cost of equity X (Market-cap/Enterprise value) + Cost of debt (Debt/Enterprise value)

• Cost of Equity: the risk-free rate of return plus the “equity risk premium” adjusted for the “systemic risk” involved in the equity.
• Risk-free Rate of Return: redemption yield on a long-term US Treasuries.
• Equity risk premium: the amount by which the return on equities exceeds the risk-free rate of return over the longer-term.
• Systemic risk (beta): the degree to which the shares of the stock in question are more or less volatile than the market as a whole. A share with a beta 1.5 would rise 15% if the market rose 10%.
• Cost of equity: is always calculated as a monetary value.
• Cost of debt: the monetary value that equates to the yield to maturity on the company’s debt, since this will reflect the market’s view of the risk of the debt relative to a risk-free band.
• Market-cap: stock market value (#shares X share price).
• Enterprise Values: adjusted market-cap for a balance of cash or debt.

This calculation, as you can see, has a lot of variables and assumptions–which means the person doing the calculation has plenty of room for making errors and will thus have less confidence in the final result used alone to make any decisions. The calculation is nonetheless interesting–especially the idea of discounting future earnings by an appropriate risk-free rate of return–which will be an essential concept in Prof Sage’s Intrinsic Value calculation (Discounted Cash Flow).

Internal Rate of Return: (IRR) calculates the overall annual percentage rate of return on an investment, especially where several different variables are involved. In the case of bonds, the redemption yield is an internal rate of return. It takes into account variables such as periodic interest payments, the price paid, the time to maturity, and the price at redemption. In its simplest form, where a single purchase and a single sale are made, and no income is received in the meantime, the IRR is the compound annual rate of return calculated from the buying price to the sale price.

IRRs are used by venture capitalists to set a target “exit price” and then work backwards to determine what up front investment is attractive. IRR can also be applied to calculate reinvested return on equity (stocks) when calculating the compound return implied by an investment. Of course, the goal is to achieve an IRR that is well above the prevailing risk free rate of returns.

Redemption Yield/Risk Free Rate of Return: is sometimes called “yield to maturity”. It is a concept most often applied to fixed income securities, like bonds, but also has applications to equity (stock) investing. The redemption yield has three components:

1. the running (or interest yield) on a bond;
2. interest-on-interest that would be earned if successive interest payments were reinvested; and
3. the annual rate of capital gain or loss that would be made if a bond were held until maturity and repaid at its issue (or “par”) value.

Redemption Yield = Running yield + Interest-on-interest + Gain/loss on maturity

The concept of a “Risk Free Rate of Return” is important for calculating the intrinsic value of a business (as we’ll see later). US Treasuries (bonds backed by the full faith of the US government) are considered to be as close to “risk-free” as one can get. If the US government can’t make payments on their debt, we all have bigger problems to worry about than our portfolio!

Bonds (treasuries) are not risk free, in fact the value of a bond in the secondary trading market will move inversely proportional to prevailing interest rates. When interest rates rise your bonds lose value and vise-versa. However, if you hold them to maturity, you are guaranteed you coupon interest rate and return of your initial capital-leaving only inflation as your enemy.

Premium/Discount to NAV: The premium/discount to NAV is the percentage difference between the share price and the per-share net asset value. If the share price is below per-share NTA, it is said to trade at a discount to NAV; if it is above NAV, it is said to trade at a premium to NAV. Net Asset Value is, similar to book value, is the value placed on all tangible assets of a company.

Premium/Discount = (Share price X 100/NAV) – 100

The more successful management is to consistently increase the value of a company’s assets, the more likely investors will be willing to pay a premium over the asset value today. Net asset value is not easy to calculate for most businesses, thus it is most commonly used only for unit trusts or property companies where the calculation is pretty straight forward.

Burn Rate: a popular financial ratio of the dot-com era, is used to determine the number of months before a loss-making company’s cash resource are extinguished. It is calculated by first determining the monthly operating expenses (burn rate), and then dividing this figure into the net cash reserves.

Months to zero cash = Net cash / Net cash operating expenses per month = Net cash /Burn Rate

No company can tolerate losses forever. Eventually they will run out of capital and have to shut their doors and fire all employees. The burn rate helps an investor assess how soon this dark day may arrive. Calculating this ratio quarter-by-quarter can help an investor monitor how progressively the business is increasing sales and decreasing expenses, thus extending the dooms day date, and even one find day emerging with a net profit.