Saturday, November 22, 2008

The Little Book of Value Investing by Christopher H. Browne


Balance Sheet - how much money the company owes and its net worth
  • Current assets : cash and assets that can be turned into cash in a relatively short period
    • T-bills
    • Inventories that are finished products ready for sale or products that are in process of being manufactured
    • Receivables from customers who have bought their products
  • Current liabilities : debts that fall due within a year or less
    • Interest payment on company borrowings
    • Account payable to the company's suppliers
    • Taxes owed but not yet paid
  • Current Ratio = Current Liabilities / Current Assets
    • Companies ability to pay its short-term obligations
    • Guideline: 2-to-1 ratio
    • Compared with other companies, LOWER ratio means possible LIQUIDITY PROBLEM
    • Steadily declining year over year means SERIOUS LIQUIDITY PROBLEM
  • Working Capital = Current Assets - Current Liabilities
    • Guideline : The more the better
  • Quick Ratio = (Current Liabilities / Current Assets) - Inventories
    • Rising inventories may indicate a product that has decreased in popularity and will be difficult to sell at a profit
  • Long-term assets
    • Real estate, Factories, Warehouses and equipment
    • Investment in subsidiaries or stocks that is not intended to be sold
    • Intangible assets such as patents, trademarks, copyrights (usually not taken into consideration because difficult to get exact valuation)
  • Long-term liabilities
    • Bank loans
    • Public and private bond issues
    • Long-term leases for property or equipment
  • Shareholder Equity (Book value) = Assets - Liabilities
    • Liabilities growing faster than assets means company has to borrow more and more money just to stay afloat
  • Debt-to-Equity Ratio = Total Debts / Shareholder Equity
    • Guideline: less than 1
    • If number is higher than 1, company is funded primarily by debt rather than equity investment

Income Statement - how much money the company took in over a period of time (sales or revenue) and how much it paid out (expenses)
  • Company's sales or revenues
    • To be compared to previous years
    • Guideline: Revenues growing over time
  • Cost of goods sold : direct cost of producing product or service the company sells
    • Raw materials
    • Manufacturing or labor costs of making product
    • INCREASING % of (COGS / revenues) means rising costs that cannot be passed on to the costumers are squeezing the long-term potential for profit
  • Gross profit = Revenues - COGS
  • % Gross Profit Margin = Gross Profit / Revenues
    • Guideline: steadier gross profit margin means better business
  • Operating expenses : selling, general and administrative expenses
    • Guideline: Lower % of (Operating Expense / Revenue) is better
  • Operating Profit (EBIT : Earnings Before Interest and Taxes) = Gross Profit - Operating Expenses
  • Net Profit (Final Earnings) = Operating Profit - Interest Expense - Taxes - Depreciation
  • Earnings Per Share (EPS) = Net Profit / Outstanding Shares
    • Diluted EPS : taking into consideration stock options, issued bonds, preferred stock or warrants are converted to stock
    • Guideline : Diluted EPS very much lower than EPS means earning is not as cheap
    • Recommended to use EBIT instead of Net Profit
  • Questions on Trend over 5 or 10 years:
    • Are revenues rising or falling?
    • Are expenses staying in line with revenues?
    • Are profits consistent or uneven?
    • Is there a cyclical pattern to earnings such as would be the case with economically sensitive companies?
    • Are profits growing?
    • Are there a lot of one-time charges or gains to indicate the company may be manipulating or massaging the bottom line?
    • Are shares outstanding decreasing?
      • Rising shares outstanding indicate excessive stock options are being granted to executives and will dilute share of corporate profits
      • Company is financing itself through stock offerings rather than earnings
  • Return on Capital (ROC) = Earnings / Beginning Year Capital (stockholder Equity + Debt)
    • Rising ROC means company is doing a good job of reinvesting profits
  • Net Profit Margin = Earnings / Total Revenues
    • Guideline: avoid companies with declining Net Profit Margin

The book The Little Book of Value Investing (Little Books. Big Profits)The Little Book of Value Investing (Little Books. Big Profits can be obtained from Amazon.