Learn to earn - Benevolent Brokers

Learn to earn

Start to learn the BASICS

Imagine your fish is named Warrie. Warrie would like to learn more about stocks and maybe even start investing part of his income in order to have a good future. The problem with Warrie is that he is a full-time fish heart surgeon, which means he does not have time to put in enough effort to make good investment decisions.

Luckily, here is the Benevolent Brokers Learn to Earn page, where Warrie can obtain the knowledge needed to start value investing. Even if Warrie is in doubt he goes back to this page just to be sure!

Enjoy the learning process, after you did this investing will be easier, better and more fun.

Price

No negotiation possible

The amount of money you pay for a share. It is impossible to know why the price of a share is up or down on a day, nor should you care. It only says something about supply/demand dynamics: when demand for a share is high (i.e. a lot of people buy), prices rise. When demand for a share is low (i.e. a lot of people sell), prices decline. Why do people buy and sell? Nobody knows. It could be the news, it could be the weather, it could be a response to analyst reports about expected earnings. The market is known to be irrational at times and possesses contradictory traits, for instance as a result of groupthink. The most important thing to remember about price, is that it does not reflect the underlying value of the company in question. As value investors, we profit from inconsistencies of the market by buying companies with a price that is lower than the intrinsic value of a company.

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Value

Where it’s all about

How much a company is worth based on intrinsic characteristics of the company. The process of calculating and assigning value to a company is called valuation. The value of a company can be assessed on the basis of many factors, including multiples or analysis and prediction of future cash flows. As value investors, we look for companies that have a significantly higher intrinsic value than the share price suggests.

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Value Investing

What we do & explain (type of investing)

The process of buying companies that have a higher intrinsic value compared to their share price. The intrinsic value of a company is determined by thorough analysis.

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Margin of Safety

Stay safe!

A key principle in value investing to safeguard against potential faulty assumptions that are made in the process of valuing a company. It protects the investor from the results of a faulty valuation (i.e. the loss of capital). It is a tenet of investing by which an investor only buys a stock if its trading below the calculated intrinsic value by a certain amount. For instance, if the calculated intrinsic value of a stock is 10 dollars per share and the margin of safety is 40%, the investor only acquires shares of the stock if its price per share is 6 dollars or less.

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Market Cap(italization)

No cap

The amount of money needed to buy all outstanding shares of a company based on the current price of a share. Or in formula: market cap = current share price * total shares outstanding. Because market cap depends on share price, the market cap changes constantly based on market sentiment. We like to say that in the short-term the market is a voting machine, but in the longer term it is a weighing machine.

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Small-cap Companies

Little Cap

Companies with a market cap below 2 billion dollar.

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Mid-cap Companies

Medium Cap

Companies with a market cap between 2 billion and 10 billion dollars

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Large-cap Companies

Serious Cap

Companies with a market cap over 10 billion dollars

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Revenue

Milionair!

The total amount of money generated by the company through sales or services.

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Earnings (or Net Income)

It’s net income

The amount of money a company makes when all expenses, taxes and interests are subtracted from the revenue.

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Earnings Per Share (EPS)

Spoiler: it is not hard

Total earnings divided by the total number of outstanding shares.

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Price-To-Earnings (P/E)

Very briljant metric

A valuation metric that compares a company’s current share price relative to its total earnings per share, or the market cap of a company to its net earnings. The P/E-value basically tells us how much we pay for the earnings of a company. A high P/E-value may indicate that a stock is overvalued. A high P/E ratio indicates that you pay a higher expectation value compared to current earnings potential. In other words you are paying a premium for an uncertain future, which we do not deem wise.

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Earnings Yield

Even nicer metric

The reciprocal of P/E (i.e. E/P). Earnings yield basically tells you how much cents you earn for every invested dollar. Suppose the earnings yield is 10%, this means that every invested dollar would return 10 cents in a year, making a total of 1.10 dollars. If the earnings yield is 25%, this would mean that every invested dollar returns 25 cents in a year, making a total of 1.25 dollars. Since earnings yield is the reciprocal of P/E, earnings yield is high when P/E is low, while earnings yield is low when P/E is high.

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Assets

Machine, Car, Land, yo mama

All the things a company owns that add financial value or help generate it, now or in the future. They can be physical, like a car or a machine (tangible assets), or non-physical, like a patent or brand reputation (intangible assets). For a company, an asset may generate cash, reduce expenses or improve sales.

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Liabilities

Don’t lie

All the things that a company owes to other parties, usually a sum of money, goods or services. They are the opposite of assets and cost the company financial value.

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Current Ratio

Progressive ratio

A metric that measures a company’s ability to meet its short term (i.e. current, or due within one year) financial obligations using its current assets (i.e. resources a business expects to convert into cash, sell or consume within one year). In general, a ratio above 1.0 indicates financial health.

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Book value

How much is your book worth?

The net asset value of a company is calculated as total assets minus total liabilities. This represents the theoretical value if all assets were liquidated at their balance sheet amounts. This is also called equity.

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Equity

See book value

Stay sharp! Go to the Book Value

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Book Value Per Share

Hard metric

No, joking it’s easy! The total book value of a company (i.e. equity) divided by the total number of outstanding shares.

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Price-to-Book-Value (P/B)

Another hard metric

A valuation metric that compares a company’s current share price relative to its total book value per share, or the market cap of a company to its total book value. The P/B-value basically tells us how much we pay for the book value of a company.

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Debt

For Gen Z, not the same as dab

Money borrowed by a company that must be repaid with interest (e.g. loans, bonds).

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Interest Coverage Ratio (ICR)

More ratio

A metric that measures a company’s ability to pay interest on outstanding debt using its operating profit. In general, a higher ratio indicates better financial health.

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Debt-to-equity (D/E)

More ratio, this one about risk

A ratio that indicates how much debt a company is using to finance its operations. It is calculated by dividing a company’s total liabilities to its equity (or book value). In general, a lower D/E-ratio indicates less reliance on debt to finance current operations and hence less “risk”. A higher D/E-ratio indicates more reliance on debt to finance current operations and hence higher “risk”.

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Free-cash flow (FCF)

#Freecashflow

The amount of money a company has left after spending money to support and maintain its operations and capital assets. This is a more accurate measure of profitability, as it reflects the true amount of cash available to a company to re-invest in itself (for growth), pay creditors or distribute to investors as dividends. Compared to Net Income this is a more reliable metric. Net Income is an opinion, but cash is a fact.

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Discounted Cash Flow (DCF) Analysis

You get discount

A valuation method that estimates the value of a company based on its expected future cash flows, adjusted back to present value using a discount rate. This method has its foundation in the principle that the value of an asset is the present value of the generated cash flows that are expected as a result of the use of the asset. Using a DCF-analysis, one can determine the intrinsic value of a company. There are many ways of doing a DCF-analysis based on the input variables used in the formula and the weight attributed to projected growth (i.e. no-growth assumption vs. fixed-growth assumption).

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Discount rate

You get more discount

The interest rate used in a DCF-analysis to evaluate the present value of future cash flows. Roughly speaking, it represents the cost of capital for companies or the minimum expected return for investors. It is the rate that compensates the average investor in a company for the time value of money and risk. The discount rate heavily influences the outcomes of a DCF-analysis.

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Enterprise Value (EV)

Formula needed….

A more comprehensive metric than market cap that represents a company’s total theoretical takeover price. It includes the company’s debt and cash and is calculated by the following formula: EV = market cap + total debt + preferred stock + non-controlling interest – cash and cash equivalents. It is used to calculate the cost of acquisition.

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Earnings-before-interest-and-taxes (EBIT)

A measure that represents a company’s operating profit prior to the payment of interest and taxes. In other words: the profit a company generates from its main activities, also called operating profit. It allows investors to compare companies with different debt levels and tax situations by focusing on profit from operations.

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EV/EBIT

Two for one!

A multiple that is used to compare a company’s enterprise value to its operating earnings. It is comparable to P/E in the sense that it can be used to assess whether a company may be overvalued, but provides a more complete overview of the company’s economic value by comparing total enterprise value to operating earnings, instead of merely market cap to net earnings. A low EV/EBIT suggests that acquisition of the company is relatively cheap compared to its operating earnings. It is also called the Acquirers’ multiple, a term coined by Tobias Carlisle.

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Discounted Cash Flow (DCF) Analysis

You get discount

A valuation method that estimates the value of a company based on its expected future cash flows, adjusted back to present value using a discount rate. This method has its foundation in the principle that the value of an asset is the present value of the generated cash flows that are expected as a result of the use of the asset. Using a DCF-analysis, one can determine the intrinsic value of a company. There are many ways of doing a DCF-analysis based on the input variables used in the formula and the weight attributed to projected growth (i.e. no-growth assumption vs. fixed-growth assumption).

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Return on Invested Capital (ROIC)

Key metric

A key profitability metric that indicates how well a company is able to create value (return) by investments in assets. Company’s with a high ROIC are better able to create value than companies with a low ROIC.

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Weighted-Average-Cost-of-Capital (WACC)

Heavy weight or light weight

A metric that assesses the costs to a company of raising capital through equity and debt. It reflects the average rate a company must pay to finance business. Its calculation can be complex due to varying assumptions regarding inputs and market conditions. WACC is often used as a discount rate in DCF-analysis.

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Value Creation

Create value for everyone

The capacity of a company to create economic value through its assets. For assessment of value creation, ROIC and WACC are compared. When ROIC is higher than WACC, value is created. When WACC is higher than ROIC, value is destroyed. It is important to remember that ROIC and WACC tend to converge in an open-market due to the effects of competition.

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