Equity Flashcards
ADRs vs. Ordinary Shares
American Depository Receipts: a negotiable certificate (or note) issued by a U.S. bank representing ownership of shares in a foreign stock that is traded on a US exchange; ADRs are denominated in U.S. dollars
Ordinary shares: Shares held in local currency
Dividend Discount Model formula
Value of stock = dividend per share / (discount rate - growth rate)
Free Cash Flow formula
Financial measurement of a company’s ability to enhance shareholder value, grow or expand
Operating cash minus capital expenditures
FCF = EBIT (1-tax rate) + (Depreciation and Amortization) - (Change in Working Capital) - (Capital Expenditure)
Weighted Average Cost of Capital
calculation to determine the total cost of all forms of capital, equity, debt, preferred, etc.; each category is weighted proportionately to determine overall cost of funds
WACC= E/(D+E)(Re) + D/(D+E)(Rd)(1-t)
E&D = market value of equity & Debt
Re & Rd = cost of equity & debt
t = corporate tax rate
current ratio
(current assets)/(current liabilities)
quick ratio
(cash + cash equiv + short-term investments + receivables)/(current liabilities)
How to calculate a cap-weighted index
proportional representation in the index; the value of a cap weighted index may be computed by summing the value of all market capitalizations and dividing by the number of stocks in the index
Advantages & disadvantages of cap-weighted index
Advantages
•total return of the index roughly mirrors the change in the total market value of all stocks.
•Rebalancing this type of index is simple.
•Since the index automatically adjusts to changes in stock prices, tax efficient mutual fund or ETF to track
Disadvantages:
• If stock prices reflect emotions over the short term, then the index will systematically own too much of overpriced stocks and too little of bargain priced stocks.
• The index is heavily influenced by the few companies with the largest market capitalizations.
Advantages & disadvantages of fundamentally weighted index
Advantages
• Since the index is not influenced by price, it is not influenced by short term emotions. Unlike market cap weighted indexes, pricing errors are random.
• Since fundamental rankings between companies are based upon sales, book value and other measures of economic size that change relatively slowly, the index can be managed through ETFs or mutual funds on a relatively tax efficient basis.
Disadvantages
The index does not use relative or absolute value to determine company weights in the index.
Advantages & disadvantages of equal weighted index
Advantages
•The index is highly diversified with all stocks in the universe equally weighted.
•As opposed to market cap weighting, the index does not overweight overpriced stocks and underweight underpriced stocks. Pricing errors are random.
•Easy to construct relatively tax efficient ETFs and mutual funds.
•Usually adds 1-2 percent in annual return over long periods after expenses vs. market cap weighted indexes.
Disadvantages
•No distinction is made between the relative or absolute valuation of stocks within the universe.
• Difficult to keep the stocks in the index equally weighted due to constant price fluctuations.
• Difficult for this type of index to manage substantial amounts of money due to the need to invest equal amounts in both the largest and smallest stocks.
PEG Ratio
Interpreting ratio
PEGR = (P/E)/EGR EGR = expected growth rate per year
PEGR = 1 to 2: normal range of value
PEGR < 1: stock is undervalued
PEGR >2: stock is overvalued
CAPE or Shiller PE Ratio
(share price)/(10-year earnings average adjusted for inflation)
Book value
Same as shareholder’s equity = assets - liabilities
P/B equations to know
P/B = (market price)/(assets - liabilities)
Multiply right side by earnings/earnings & move P/B & 1/E to opposite sides:
E/P = ROE / (P/B)
Or
P/B = ROE*(P/E)
P/S ratio
(market value)/(12 month sales)
